The Australian economy is expected to experience stronger growth this year on the back of greater domestic demand, a leading index shows.

The Westpac-Melbourne Institute leading index of economic activity, which indicates the likely pace of activity three to nine months into the future, posted an annualised growth rate of 7.6 per cent in November.

The growth rate, released on Wednesday, was well above its long-term trend pace of 3.0 per cent.

The annualised growth rate of the coincident index, which shows the current pace of economic activity, was 0.5 per cent, below its long-term trend of 2.9 per cent, however.

Westpac’s chief economist, Bill Evans, said he continued to be surprised by the pace of recovery in the growth rate of the index.

“Over the last six months, growth has accelerated from minus-3.2 per cent in June to the current 7.6 per cent,” he said.

This represented the fastest recovery in the growth rate of the leading index since the economy bounced out of recession in the mid-1970s.

“In through-the-year terms, we expect the growth rate of domestic demand to bounce back from around 1.25 per cent in 2009 to 4.25 per cent in 2010,” Mr Evans said.

Domestic demand would be supported by much stronger momentum in consumer spending.

Mr Evans forecast 3.75 per cent growth in consumer spending in 2010 from 2.25 per cent growth in 2009, with dwelling construction increasing by 17.25 per cent from zero per cent, while business investment was expected to grow at 3.5 per cent from minus-5.5 per cent.

Westpac says the annualised growth rate of 0.5 per cent in the coincident index suggests real GDP growth in the December quarter is not likely to rebound strongly from its modest 0.2 per cent outcome in the September quarter.

Meanwhile, the recovery in gross domestic product (GDP) growth would be more subdued, rising from two per cent in 2009 to 3.5 per cent in 2010.

Three of the four monthly components of the leading index rose in November, with only one component, real money supply, falling by 0.4 per cent.

In the coming year, the bank expects inventories will be fairly stable adding very little to GDP growth.

Net exports also are likely to add about one percentage point less to GDP growth in 2010 than in 2009.

“Despite a much stronger export performance in 2010, the recovery in import growth in 2010 is likely to more than neutralise the export effect,” Mr Evans said.

Westpac said it expects another interest rate increase of 0.25 per cent when the board of the Reserve Bank of Australia meets next on February 2, with the likelihood of another two increases of 0.25 each by June.

“The evidence from the Leading Index, the Westpac Melbourne Institute Index of Consumer Sentiment, the labour market, and recent trends in retail sales indicates that the Bank will be keen to move monetary settings back to a level where interest rates are no longer stimulatory for the economy,” Mr Evans said.

“A recent speech from an RBA official indicated that such a level for their overnight cash rate might be expected to be around 4.5 per cent compared to the current 3.75 per cent.

“Accordingly, we expect to see another rate hike of 0.25 per cent to be announced by the Bank on February 2 with the likelihood of another two increases of 0.25 per cent each by June.”

The index result comes a week after the Westpac-Melbourne Institute index of consumer sentiment increased by 5.6 per cent to 120.1 points in January, from 113.8 in December.

The strong result, which has been attributed largely to robust jobs growth, follows slides in confidence in November and December.