New Zealand is in recession, but economic activity should pick up at the end of the year, according to the Treasury.
In its review of economic statistics for July, it says it believes that when official data is released, it will show the economy shrank in the three months to the end of June.
A recession is defined as two consecutive quarters of negative growth. In the March quarter, the economy contracted.
Treasury says business activity dropped in the June quarter and household spending was expected to have fallen.
Reserve Bank governor Alan Bollard says the situation is making it possible to lower interest rates further. "In a softening economy, people are going to be very hesitant about price increases and things like that, so that's given us enough room to cut."
Dr Bollard says he expects a softening in the labour market to materialise within a year - despite figures released on Monday showing rising wages and salaries.
Treasury is also forecasting growth will be stagnant in the three months to the end of September. On that basis, it is predicting the economy will only grow about 0.5%, or possibly 0.75%, this year.
Treasury says it believes the year will end positively, with growth expected to pick up in the last three months. It says tax cuts, the end of the drought, a weakening New Zealand dollar and further interest rate cuts will boost economic activity at the end of the year.
Finance Minister Michael Cullen says the country has been through a flat period, as have a number of other developed countries, especially those with a high level of investment in the property sector.
National Party leader John Key says the Treasury report confirms the importance of the cautious view National is taking in putting together its tax cut programme, and that it will not be borrowing for tax cuts. He says it also shows why New Zealand needs a plan to grow.
Debate on borrowing
MPs argued in Parliament on Tuesday about the National Party's plan to borrow to pay for infrastructure investment.
National's leader, John Key, led the debate by questioning the Prime Minister over her previously expressed views on government borrowing and by defending his party's spending plans.
Mr Key thinks National's plan to cut taxes and to spend more on building infrastructure is particularly timely now the economy has slowed. But the Government says that will put the economy further at risk.
Fears for wages
The Council of Trade Unions hopes a recession will be short-lived and will not drag down wages.
The CTU's economist, Peter Conway, says past experience has shown movements in wages lag fluctuations in output. He is hopeful workers will not face wage cuts before the predicted upturn.