Economy set to slow as rates bite

The economy will slow in 2005 as last year's six interest rate rises gradually dampen domestic demand and stifle nagging inflation pressures, a Reuters poll of economists shows.

The economy is expected to grow 2.3 per cent in 2005, higher than the 2 per cent growth forecast in a previous poll in November but about half the 4.9 per cent growth forecast for 2004, a quarterly survey of 10 research houses found.

The domestic economy has remained strong for longer than expected, but reduced immigration gains, an expected cooling of the housing market and the lagged effect of the strong dollar are expected to slow robust consumer spending.

"It's really a domestic demand slowdown that this economy needs and for the most part we're forecasting that to happen," said Bank of New Zealand treasury economist Craig Ebert.

The Reserve Bank raised interest rates by a total of 1.5 percentage points last year to combat inflation, which it has forecast will remain at the top of its target band of 1 to 3 per cent for the next two years.

Economists expect consumer prices to be 2.4 per cent higher in 2005, a little lower than previously forecast and the actual 2.7 per cent rise in prices in the past calendar year.

The central bank last Thursday left interest rates unchanged at 6.5 per cent, the highest rate in the developed world. It is expected to leave rates on hold until an easing in the third quarter.

The strong dollar, which has risen 75 per cent in the past three years, is expected to continue to dent export earnings and bring a further deterioration in the trade deficit.

The current account deficit for 2004, when it is announced, is expected to have swelled to $9 billion and 2005's is expected to be forecast at $9.5 billion, outstripping the $7.6 billion and $7.7 billion deficits predicted just three months ago.

This, combined with a substantial narrowing of the gap between NZ's high interest rates and the rest of the world, is expected to weigh on the currency.

The dollar is expected to pull back to 68USc by June, retracing to 66.5 USc by year end, 8.5 per cent below December's 16-year high of 72.7.

The poll comes as the Reserve Bank raised its estimate of the rate of economic growth the country can sustain without inflation getting out of hand.

The bank says the potential growth rate is now around 3.7 per cent. This compares to an average economic growth of 3.4 per cent over the past 10 years, one of the highest among developed countries and up from 1.5 per cent in the decade before that.

Bank governor Alan Bollard, however, said that for the economy to keep growing productivity would have to improve to compensate for an ageing workforce.

- REUTERS