Key Points:

An influential international body has told the Government to focus on tax cuts and curb spending to help the economy through a difficult period.

The International Monetary Fund warns of a risk of a sharper economic "correction", and says although some factors would mitigate a potential slowdown, "the economy might be in for an uncomfortable period".

The report says the Government's fiscal policy is adding stimulus to an already over-heated economy, and tax changes expected in the Budget could make that worse.

The firm message from the Washington-based organisation highlights the difficulties Finance Minister Michael Cullen faces as he prepares to deliver his eighth Budget next week.

With the Government's books again proving to be healthier than expected, there will be money for Dr Cullen to spend.

But that temptation is tempered by the risk of adding to inflationary pressures, and the unwelcome prospect of giving the Reserve Bank another reason to raise interest rates further.

Critics of Dr Cullen yesterday seized on the IMF's report as evidence that his fiscal policy is contributing to pressures on interest rates.

But Dr Cullen noted that the report, researched by IMF staff during a visit here in February, also suggests he has little room to change his policy.

"It's a little bit confused when it says that we can't do much to change Government spending over the short to medium term but that there are fiscal pressures over the medium to longer term," he said yesterday.

The IMF report will not affect Dr Cullen's Budget, which was signed off in the middle of last month.

The minister also defended his position by questioning the effect that National's tax-cut programme - on which it campaigned in the 2005 election - would have had on inflation if it was now coming into effect.

"It does mean that we have not had anything like the fiscal expansion that National was planning for the current term of this Parliament, which by now would be putting $3 billion a year extra of tax cuts into the economy."

National has been arguing for weeks that Government spending is one of the major reasons interest rates have been rising.

That has been supported to some degree by statements from Reserve Bank Governor Alan Bollard.

The Budget is expected to deliver a cut in the corporate tax rate to 30 per cent from 33 per cent, as well as potentially flow-on effects for personal tax.

Hints so far have suggested that the personal tax changes could be largely linked to the Government's KiwiSaver retirement savings scheme, and therefore avoid being inflationary.

But the IMF is concerned that the tax changes and spending expected in the Budget will further stimulate demand when it is least needed.

It suggests the Government should consider delaying the stimulus, perhaps by slowing the timing of its current spending plans.

National Party finance spokesman Bill English said yesterday the IMF report - just two weeks after the OECD suggested delaying Government spending would help keep interest rates lower - confirmed that Labour's policy would push interest rates higher for longer. "The IMF report highlights lost opportunities."

The IMF report also talks of improving productivity in the health system, increasing the eligibility age for superannuation payments and cutting tax breaks on housing-related investments.