A leading pointer to future economic growth suggests a strong recovery in 2010, fuelling the need for higher interest rates in coming months.

The annualised growth rate of the Westpac-Melbourne Institute leading index was 1.7 per cent in August, recovering to just below its long-term trend of 2.8 per cent.

The index, which indicates the likely pace of economic activity three to nine months into the future, has rebounded sharply from the reading of minus 6.9 per cent in May.

“The pace of recovery in the growth rate of the leading index has been remarkable,” Westpac chief economist Bill Evans said when releasing the data on Wednesday.

“The current sharp improvement … strongly supports the view that the Australian economy is moving onto a much stronger growth trajectory in 2010.”

The clear signal was that the official cash rate would need to move away from its present “highly expansionary” setting, he said.

Market economists are toying with the need for a 25 or 50 basis point increase in the cash rate when the Reserve Bank of Australia (RBA) holds its next board meeting on Melbourne Cup Day (November 3).

Mr Evans said there appeared to a “particular unease” in recent speeches and reports by the RBA about its underlying inflation forecast by the end of 2010, which is expected to move back from 3.9 per cent currently to two per cent.

“The release of the September quarter inflation data on October 28 may show that the quarterly pace of underlying inflation has actually picked up,” he said.

“In those circumstances, a decision to raise rate by 50 basis points in November would not surprise.”

The RBA raised the cash rate by 25 basis points to 3.25 per cent at its October board meeting, the first increase in 19 months.

AAP