The economy is expected to grow 2.5 per cent this year and 3.4 per cent next year, but the New Zealand dollar is expected to peak around US87 cents late this year, according to Bank of New Zealand economists.
"New Zealand still looks a relatively good place to be when compared with most of the developed world," BNZ economists said.
BNZ head of research Stephen Toplis said that while the global environment had improved in recent months, significant threats remained.
"From New Zealand's point of view, the strength of its nearest neighbours, rather than the US and Europe, are of greatest interest. While the consensus view about the Australian economy is that it will remain one of the fastest growth areas in the developed world, there are increasing risks to this view.
"Our exporters are exposed to the Australian economy, and this is facing some significant obstacles to its export sector, including cost structure increases, a high Australian dollar and a lower-cost-supply response elsewhere in the world. However, how China performs will also affect Australia's strength, and there is good reason to be optimistic."
While the global risks were "abating", the outlook remained far from certain, with New Zealand still vulnerable to events elsewhere, a "potentially overheating housing market and the accompanying strength in the New Zealand dollar".
Despite the relatively strong growth expected in the next couple of years, inflation is expected to stay broadly in check, thanks to the high dollar, weak job market and a low starting point for inflation.
BNZ raised its expectations for the next two to three years because the Christchurch rebuild would be larger than earlier expected and building work elsewhere looked "much more robust" as surging house prices sparked more construction.
The high dollar was also expected to see greater investment in plant and machinery. A stronger housing market would also support "modest" consumer spending growth, as would continued low interest rates, BNZ said.
The currency was expected to stay up, peaking at around US87c late this year. The dollar traded about US84.3c yesterday.
"The potential for the New Zealand dollar to forge even higher than we are forecasting is probably the number one risk to both our growth forecast and our interest rate track," BNZ said. A higher dollar could undermine growth and see a lower interest rate profile than expected.
BNZ's forecasts for growth follow a survey on the services sector out yesterday which showed new orders and activity growing, although hiring is still in the doldrums. That came on the back of a better picture for manufacturers and retailers last week.
Overall, the BNZ-BusinessNZ Performance of Services Index was 52.6 points in January, up 1.1 points from December, stemming falls in the previous two months.
An index above 50 indicates the service sector is expanding; below 50 that it is contracting.
Yesterday's service sector survey showed a "very encouraging" rise for new orders/business, which was in healthy expansion at 57.6, while activity/sales was 53.5. Both indexes were better than December.
But in contrast, employment, at 49.9, slipped back after a slight pickup in December.
- © Fairfax NZ News