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Economy to grow below potential: OECD

Lower domestic interest rates can be expected as a high exchange rate and a tight federal budget leaves the Australian economy growing at "slightly below potential" over the next two years, a global agency has warned.

The Organisation for Economic Cooperation and Development (OECD) has also advised the Labor government to delay its planned budget surplus if the local economic situation deteriorates significantly.

"Activity should remain sluggish in many sectors that must adjust to a strong dollar, and budget tightening will damp demand in 2012/13," it said in its latest economic outlook on Tuesday.

"These factors will be partially offset, however, by easier monetary and financial conditions, which should stimulate housing investment."

While the Paris-based institution upgraded its 2012 Australian growth forecast to 3.7 per cent, from 3.1 per cent six months ago, it slashed the 2013 prediction to three per cent, from 3.7 per cent, and now expects growth of 3.2 per cent in 2014.

The OECD forecasts are based on the Reserve Bank of Australia (RBA) further reducing the cash interest rate, which now stands at 3.25 per cent.

However, it also anticipates mining investment to continue to expand "vigorously" in 2013, while export growth should gather pace as mining capacity expands and the global environment improves in 2014.

But a pronounced slowdown in China would hamper exports and Australia's term of trade, and an increase in the overall world supply of commodities would weaken raw materials prices.

"If the economic situation were to deteriorate significantly, the authorities should let the automatic stabilisers work and should slow budget consolidation," the OECD said.

It also says if Australia is to sustain a robust rise in its standard of living, it must pursue taxation, infrastructure and innovation reform to bolster productivity.

Beyond the Asia region, OECD deputy secretary-general and chief economist Pier Carlo Padoan warned the global economy was weakening again.

"The risk of a new major contraction cannot be ruled out," Mr Padoan said in the report.

He said the key driver for the downturn was a significant drop in confidence in the face of "insufficient and ineffective" government policy responses.

"The fiscal cliff and the debt ceiling in the United States, and the management of the euro area crisis are two cases in point," he said.

Growth across the OECD's 34-country membership is expected to match this year's in 2013 at 1.4 per cent, before expending to 2.3 per cent.