Food prices are set to rise next year as the effects of a severe drought in the United States drives up grain prices and other feed stocks, according to the New Zealand Institute of Economic Research.

However, a slow economy with little inflation and global uncertainty means the Reserve Bank will keep interest rates on hold till 2014, NZIER says in its latest quarterly predictions.

NZIER principal economist Shamubeel Eaqub said prices for grains including corn, wheat and soy had increased by between 15 per cent and 30 per cent on last year.

Those higher costs would flow through the food supply chain, and could lead to a 6 to 7 per cent increase in average food prices early next year, he said.

“We expect to see food prices start to rise quite considerably in the early part of next year.”

While the higher prices were still to flow through to meat and dairy prices, it was only matter of time, Eaqub said.

Higher commodity prices were a boon for farmers, but would weigh on already stretched household budgets.

Household incomes had largely failed to keep pace with rising costs including electricity prices, rates and insurance.

“Particularly in lower income households there is not a lot of discretionary income, and any spikes up in food and fuel prices means that you have less money to spend on other discretionary goods,” Eaqub said.

As a result, retailers could expect a “challenging start to 2013”.

But longer term, higher commodity prices were good for New Zealand's economy, leading to farmers earning and investing more, while a higher exchange rate reduced the cost of imports including consumer products like televisions and cars.

NZIER forecasts the economy to grow at 1.7 per cent this year, rising to 2.7 per cent next year as the Christchurch rebuild gathers pace.

The rebuild would take longer than expected and the economic benefit each year would be smaller, Eaqub said.

Exports would be weak this year, particularly for non-food products, bouncing back slightly next year.

The recovery would remain tentative compared with a typical post-recession growth of 3 to 4 per cent.

But conditions in New Zealand were “generally OK”. The economy was no longer shrinking and the country was spending more responsibly and conservatively.

The slowing global economy was the biggest risk to the New Zealand economy.

“The European debt crisis is spilling over to our key trading partners in Asia and Australia, which will dent our exports,” Eaqub said.

Asian exports had slowed sharply, which was in turn affecting Australia's mining industry and had led to a number of big mining expansion plans being put on hold.

The mining sector had underpinned Australia's economy during the global financial crisis and maintained the country's demand for New Zealand exports.

China's economic growth is forecast to slow to nearly 8.5 per cent this year from an average of nearly 10 per cent last year.

While those growth figures were still strong, the decline would mean less job creation in China and less demand for New Zealand dairy and meat products.

- © Fairfax NZ News