KEY POINTS:
The current economic upswing will not be sustained, the Treasury says, and it has halved its growth forecast for next year, confident that high interest rates and flattening house prices will - eventually - sap the enthusiasm of consumers.
Recent data have shown an economy whose inward-facing parts at least are going strong: 25,000 new jobs in the March quarter, house price inflation accelerating to double-digit rates and retailers enjoying their strongest quarter since 1995.
The Treasury's forecasters, like many in the private sector, had underestimated this pick-up and in yesterday's Budget have revised up their near-term forecast. They expect the economy to grow 2.6 per cent in the year to March 2008, up from a forecast of 2.3 per cent six months ago.
But they have slashed their forecast for the following year to 1.6 per cent, from 3.2 per cent in the half-year outlook last December.
That would be similar to the year we have just had.
The dollar is expected to decline from its gravity-defying heights, albeit later and more gradually than the Treasury projected in December.
Export revenues are expected to be flat next year, weighed down by the exchange rate, and sky-high world dairy prices are not expected to last.
On the home front, mortgage payments are expected to take a bigger bite out of incomes as fixed-rate loans roll off and are reset at higher rates.
That is expected to see consumer spending slow and demand for housing to ease too, to the point that house prices fall slightly between March next year and March 2009.
The boost to demand in the economy from Working for Families and Government spending generally is expected to moderate from the March 2009 year onwards, but still contribute about 0.75 percentage points towards annual economic growth.
A slowing domestic economy will erode firms' profits and see jobs growth decline, though only to 4.6 per cent by the middle of next year.
Wage inflation is forecast to ease, to around 4 per cent, and fewer new jobs and weaker wage growth will rein in the growth in PAYE.
The forecasters acknowledge that households have shrugged off the effects of higher interest rates for some time, insulated by a strong labour market, rising wages and cheaper imports as a result of the strong dollar.
They recognise a risk that that might persist and the momentum in the domestic economy be maintained for longer than they expect.
But they expect next year's slowdown to do what last year's did not: relieve the pressure on resources which has kept non-tradeable inflation around 4 per cent since 2004.
The forecasts assume feeble recent productivity growth is a temporary, cyclical phenomenon and that it will recover to around 1.5 per cent a year.
The Treasury attributes the weakness of productivity lately to firms having hoarded labour. And they expect to see a boost to productivity from the strong levels of business investment in recent years.
Beyond next year's slowdown the Treasury's forecasters expect a return to stronger and more balanced economic growth over 2009.
Investment would pick up as exports recover, reflecting a more benign exchange rate, interest rates fall as inflation pressures ease, and businesses feel the benefit of a lower company tax rate.
Briefing reporters and analysts yesterday, Finance Minister Michael Cullen said it was important fiscal policy supported monetary policy and "leant against" growth in domestic demand.
Longer-term the Budget acknowledges that the compulsory matching of employee contributions to KiwiSaver could affect firms' profitability, at least when the level of contributions increase beyond that reimbursed through tax credits.
"It is likely that employers will seek to recoup this additional cost through lowering future wage growth or through increasing prices."
But these effects are not reflected in the economic forecasts because they will depend on the state of the economy at the time and will mainly occur towards the end of the forecast period, four years from now.
