Balance: Non-mining parts of the local economy are unlikely to pick up.

Balance: Non-mining parts of the local economy are unlikely to pick up. Photo: Paul Jones

A week away from the federal budget and the Organisation for Economic Co-Operation and Development has warned that Australia's economy is too fragile to absorb too many spending cuts.

The top economic body has also advised Australia’s economic authorities to consider intervening in the housing market to stop house prices rising too much.

The Abbott government will release its highly anticipated first budget on Tuesday, which is expected to be the harshest in years.

But the OECD – whose job it is to promote policies that will improve economic and social well-being – says the government should "avoid" pursuing too much "fiscal consolidation" at this stage in the economic cycle.

It comes after the Commission of Audit last week recommended radical spending cuts, paving the way for harsh measures around welfare, ageing and the unemployed.

But the OECD on Tuesday said resource-sector investment in Australia – which has been one of the main drivers of the economy in recent years – will keep declining as key global commodity markets cool.

At the same time, non-mining parts of the economy are unlikely to pick up.

That means the Abbott government should not dampen the economy’s chance of a recovery by cutting too heavily, too quickly.

"Given the near-term uncertainties in the rebalancing of the economy away from investment in the resource sector, heavy front loading of fiscal consolidation should be avoided," the report warns.

"Against the backdrop of the projected recovery, monetary stimulus should start to be withdrawn in the first half of 2015."

The report says Australia’s economic output is projected to grow by 2.5 per cent in 2014, and nearly 3 per cent in 2015.

However, some economic slack will remain and the unemployment rate – at a relatively-high 5.8 per cent – will not begin to fall until the second half of next year.

That means there will be little inflation pressure, which supports the Reserve Bank’s decision on Tuesday to keep interest rates at historic lows of 2.5 per cent.

But the OECD report says Australia’s economic authorities should not "rule out" manipulating mortgage lending rules as a "targeted means" to cool the housing market if house prices continue to rise.

It says the RBA’s decision to keep interest rates at record lows has been important for Australia’s economic recovery, but it has led to a search for return by investors that "requires close prudential oversight of markets".

"Tellingly, investors account for much of the recent increase in the number of housing-loan approvals," the report says.

The OECD report also points out that the Abbott government’s decision to hand $8 billion dollars to the Reserve Bank to help the RBA top up its reserve fund has contributed to the Abbott government’s projected deficit.