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Finance Minister Michael Cullen says economic conditions have worsened since the Budget, and figures out next week are likely to show the economy has shrunk in the first quarter of this year.
Dr Cullen appeared before a parliamentary select committee yesterday to discuss his Budget, and said the
economic situation was challenging.
"The economic headwinds are no less strong now than they were when the Budget was presented - in some respects they're looking somewhat stronger," Dr Cullen said.
Record high petrol prices and rising food prices are hurting households and businesses, and high interest rates have led to a sharp downturn in the housing market.
Dr Cullen said he had not been given advance notice of GDP figures due out next Friday, but it appeared obvious the economy would have shrunk. It seemed almost inevitable the quarterly figure would be negative.
"It seems most unlikely it wouldn't be, given all the other data that we've seen emerging over recent weeks."
Dr Cullen's view is not out of line with economists, but it is the first time he has publicly predicted a negative March quarter.
The minister said the effects of drought on next week's figures shouldn't be underestimated.
"We continue to receive reports which indicate the effects on some parts of the farming sector will run well into next season and potentially even beyond," Dr Cullen said.
"The drought itself, I think, will have contributed significantly to the likelihood of a negative GDP figure."
The deteriorating economy is shaping up as an election issue as Labour tries to bat off National's accusations that it mismanaged a prolonged period of strong economic growth.
Labour is seeking to ease pressure on households by introducing tax cuts on October 1, and Dr Cullen said he thought people were feeling the strain of high petrol prices more than high food prices.
That was because they could shop around and substitute some foods for others, whereas with petrol they had to get one kind and there was very little difference in prices.
Dr Cullen again warned that there was little room in the Government's books for "additional movement" - such as bigger tax cuts.
And he said big pay rises for public servants were unrealistic.
National Party finance spokesman Bill English asked Dr Cullen about the effect of future wage settlements, and received a blunt reply.
"One of the issues the Government is facing at the moment is that expectations in the public sector on wages and salaries haven't caught up with the changing economic and fiscal situation," the minister said.
"People who are asking for sort of 10 per cent-plus per annum wage and salary increases over two, three, four years I think really have lost a bit of contact with reality over what governments are able to deliver without probably then looking to cut the services they are supplying."