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Westpac's chief economist is predicting an economic "tug of war" in 2008.
High interest rates, high petrol prices and the end of the housing boom will be battling strong wage growth, tax cut incentives and dairy cash, Brendan O'Donovan said.
In its quarterly economic overview, Westpac said there was "no doubt" the house price boom was over. "We expect more price weakness to come - prices could be flat for half a decade."
The bank said high interest rates are the main force behind the housing market downturn, driving up the cost of borrowing and pushing many would-be buyers out of the market.
A drop in home-ownership will result in more people renting, and the demand will push up rents by around 6 per cent a year. While mortgage costs and petrol prices continue to rise, so will incomes, the bank predicts.
If petrol prices remain around $1.71 a litre the average household will spend $200 more on petrol in 2008 than in 2007. But, with low unemployment and labour shortages "earnings growth has gathered pace" to help offset higher expenses.
A Fonterra payout to dairy farmers of $7 per kg of milksolids should inject $4 billion into the economy.
"We firmly believe that farmers will spend the dairy cash windfall."
Westpac says inflation is pushing "perilously close" to the top of the central bank's 1 to 3 per cent target band. The bank expects inflation will rise to 3.5 per cent this year. Overall, it expects this year's gross domestic product to grow 2.9 per cent.
"These are incredibly uncertain times ... Offshore, the recent rout in global equity markets is indicative of the vulnerable state of the global economic environment," O'Donovan said. "Westpac's central scenario is still that the world economy, outside the US, will maintain a solid pace of growth through 2008."
But, he said, don't expect this year to be all plain sailing.
- NZPA