Risks 'still there' for economy: NZIER

The economy still faces significant risks despite being out of recession, the New Zealand Institute of Economic Research (NZIER) says.

Continued improvement was expected, but the next few quarters would be bumpy as the economy slowly converted the rebound into recovery, principal economist Shamubeel Eaqub said as the NZIER released its December quarterly predictions.

"There are still significant risks to the economy from renewed over-valuation in the housing market, rising unemployment, persistent external imbalances, rising oil prices and eventual withdrawal of monetary and fiscal stimulus," Eaqub said.

"There is little urgency to raise interest rates given weakness in the economy and risks to the outlook."

NZIER expected the Reserve Bank to raise interest rates from the September quarter of 2010.

It estimated the economy contracted by -0.9 per cent in the 2009 calendar year, compared to a consensus of -1.6 per cent, and expected a subdued 2.6 per cent recovery in 2010 where the consensus was for 2 per cent.

The above consensus forecast for 2010 was due to less import dependent consumption recovery and more resilient exports, Eaqub said.

"Our view on the construction sector is weaker than consensus; we expect a shallower recovery due to slowing net migration, rising interest rates and rising vacancy impacting on commercial real estate."

Household spending was set to recover in the next year due to pent up demand for big ticket items. A full fledged recovery in spending would likely take place in late 2010, when the labour market improved.

The unemployment rate may head higher towards 8 per cent in mid-2010, from 6.5 per cent now. Businesses had adjusted to weaker demand by cutting back hours rather than firing staff, which should ensure a relatively smooth return to activity when demand returned.

When the Reserve Bank started raising interest rates the extent of tightening may be less than in recent years as the Government cut back spending, the economy had significant spare capacity and households were more exposed to floating mortgages.

NZIER expected the Reserve Bank to raise the official cash rate towards 5.5 per cent by mid-2011, starting in the September quarter 2010, from 2.5 per cent now.

The New Zealand dollar may find continued support in the near term, particularly against the economically vulnerable greenback and British pound, Eaqub said.

But the medium term case for sustained NZ dollar depreciation remained in place, due to unsustainable external imbalances.

- NZPA