The economic recovery will pick up speed only slowly, the New Zealand Institute of Economic Research says, as households shed debt and the Government withdraws stimulus amid anaemic world growth.
"The economy is stagnant," says principal economist Shamubeel Eaqub, in the institute's Quarterly Predictions, released today.
Historically low interest rates are not encouraging new borrowing and investing, as households and businesses focus instead on paying down debt.
Eaqub said periods of deleveraging typically lasted seven years, which would imply we still had the second half of the adjustment to go.
The economy eked out growth of 1.1 per cent last year and NZIER is forecasting 1.5 per cent this year before it picks up to 2.5 per cent next year.
NZIER is among the more bearish forecasters. The consensus is 2.2 per cent growth this year and 3 per cent next year.
"We are less optimistic than most on the timing of the [Canterbury] rebuild, as we think persistent aftershocks, tougher building codes and insurance issues will slow Canterbury's recovery," Eaqub said.
The continued sovereign debt crisis in Europe is not the only external risk. Growth is slowing in Australia and China.
In Australia, New Zealand's largest export market, mining investment is still strong but the housing market is deflating and people are spending less.
Meanwhile Asian economies are feeling the effects of weakness in their European export markets.
"To provide another spurt of economic growth, until advanced economies come back to the party, the Chinese authorities are trying to reorient the economy toward consumption, away from exports and investment. But these changes take time."
The slowdown in Asia-Pacific growth will be a drag on the demand for New Zealand's exports and tourism.
On the home front, NZIER expects households to remain cautious about spending in the face of few new jobs and minimal real wage growth.
People with mortgages have taken advantage of lower interest rates to pay down debt rather than borrow more as in the years of the last property boom.
"This change in behaviour from insatiable borrowing to saving could last many years and restrain spending," Eaqub said.
Anaemic consumer demand would give firms little scope to increase prices and he expects the inflationary pressures from the rebuilding of Christchurch to be small.
Consequently NZIER expects the Reserve Bank to keep interest rates steady until early 2014, a year later than most other forecasters.
The bank might cut rates again if the European debt crisis worsened but the impact of any further cuts would be modest.
"Further rate cuts would provide a small benefit to existing borrowers. But savers would be hurt and new borrowing for investment is unlikely because of weakening economic conditions," Eaqub said.
Business investment in plant and equipment and new buildings remains patchy.
"It has lifted off its lows and investment intentions are positive. But there is excess capacity in swathes of the economy meaning new investment is not needed until demand picks up," he said.
"The exception is Canterbury, where they are replacing lost capital. We expect businesses to remain cautious about adding capacity until there is greater certainty of a recovery."
NZIER's forecasts are closer to the alternative downside scenario sketched in last week's Budget, predicated on either weaker growth in emerging Asia, especially China, or on a hit to global growth from an escalation of the sovereign debt crisis in Europe.
That would cut a cumulative $8 billion off the Government's tax take over the next four years, eliminating any prospect of a return to surplus in that period.
Eaqub applauds the Budget's aim of restraining spending and bringing government debt under control. Europe provides a harsh reminder of the risks of profligacy.
But he believes the Budget's assumptions are too optimistic and doubts a fiscal surplus will be possible before 2017 without further measures to raise revenue or cut expenses.
Over-65s up as under-40s dip
Population growth slowed to just 0.6 per cent in the year ended March 2012, its slowest rate for 11 years.
"Worryingly, the under-40s population declined by 0.2 per cent while the over-65s grew by 4 per cent," the Institute of Economic Research says in its Quarterly Predictions.
While it expects the sustained outflow of migrants to gradually reverse as the Australian economy slows, it warns that a shrinking population under 40 is damaging for the economy in general and rural areas in particular, which face a greater hollowing out.
That age group "represents future growth potential through entrepreneurship and labour market participation", it said.
They also tended to drive demand for new homes and durable goods.