KEY POINTS:
Michael Cullen didn't approve tax cuts or new spending yesterday, but the risk of a more stimulatory fiscal policy remains and is likely to keep interest rates high all through next year, economists say.
The Finance Minister has raised the allowance for new initiatives in the 2008-2009 year from $2 billion to $3 billion to accommodate the business tax package now being worked.
But, despite stronger economic growth and higher tax revenues than expected, the fiscal stimulus for the current year and next year were largely unchanged in the half-year economic and fiscal update released yesterday. Dr Cullen was at pains to hose down expectations for personal tax cuts.
Market economists concluded, on balance, he had not given the Reserve Bank an excuse to hike interest rates in the New Year.
"The Government has got more money to distribute if it wishes to," Bank of New Zealand economist Stephen Toplis said.
"At this stage the Minister of Finance is saying the right things in terms of fiscal austerity, but there is still the nagging question that, if they have got the money and they go into an election year and it's a bit tight, it's going to be a big ask to keep those funds from filtering into an economy that is already running at full speed."
ANZ National Bank chief economist Cameron Bagrie said the Reserve Bank would take some comfort from the fact that the allowance for both operational and capital spending in next year's Budget was unchanged.
The bank was firmly of the view that Dr Cullen would increase spending again next year, Bagrie said.
Spending would also likely be increased in an "election-charged Budget 2008".
"With $3 billion of initiatives it is already shaping up as a humdinger."
While Cullen had not provided Reserve Bank governor Alan Bollard with a smoking gun that would justify an interest rate hike, the idea interest rates would be heading down by the end of next year was looking less and less plausible, he said.
"The risk is that high rates will be sustained through 2008 as well."
Westpac chief economist Brendan O'Donovan said the Reserve Bank had added fiscal policy to its "axis of evil" alongside consumer spending and the housing market.
There was nothing in the short-term outlook on the fiscal front to worry the bank.
But, further out, with operating surplus so far this year running $800 million ahead of forecast, on top of a surplus of $11.4 billion in the year to June 2006, the pressure for additional spending or tax cuts would be great.
Dr Cullen said the economy had proved more resilient that expected.
The Treasury has revised up its forecasts for economic growth in the short term.
It bottoms out (on an annual average basis) at 1.8 per cent in the current March year instead of the 1 per cent forecast in the May Budget.
But the pick-up is slower as it takes longer for the economy to get back on an even keel.
Non-tradeables inflation - one of the imbalances of most concern to the Reserve bank - is only expected to get back below 3 per cent by September 2008.
A key judgment underpinning the forecasts is that householders will become more debt-averse next year and pull in their horns.
Investment by business is expected to taper off to reflect a squeeze on profits.
Wage growth is expected to continue above 4.5 per cent and the PAYE tax take to grow even faster as more people are pushed into higher tax brackets.
The corporate tax take, by contrast, is expected to fall 13 per cent in the current year and barely increase next year.
