* Growth slows, dragged lower by manufacturing, weak demand
* Outlook patchy and uncertain
* Interest rates seen on hold for rest of year
* NZ dollar falls nearly half a cent, debt rallies (Adds finance minister, Fonterra payout, graphic, update market)
By Mantik Kusjanto
WELLINGTON, Sept 23 (Reuters) - New Zealand's economy slowed unexpectedly in second quarter as manufacturing activity fell, further clouding its outlook and backing views that interest rates will remain on hold at least until early next year.
Gross domestic product rose a seasonally adjusted 0.2 percent in the three months to June, well below economists' 0.8 percent median forecast in a Reuters poll and the Reserve Bank of New Zealand's (RBNZ) 0.9 percent projection.
Domestic consumption, which makes up around 60 percent of the economy, was flat, after growing in the previous five quarters, while manufacturing activity fell 4 percent.
Analysts said the surprising weakness and the added impact of a recent strong earthquake would dent the economy's near term prospects and reduce the need for higher rates.
"With no real signs of a material pickup in Q3, and given the impact of the earthquake, we're in for further weakness in the near term," said ANZ head of market economics Khoon Goh.
"It will keep the RBNZ on hold, although we still expect a pickup in activity in 2011."
The New Zealand dollar fell nearly half a cent to a low of $0.7307 from around $0.7360, before trimming its losses to $0.7320. But on the cross rate against the neighbouring Australian dollar it slipped 1 percent to a five-month low of A$0.7650 on the divergent rate outlooks.
Australia has been enjoying strong growth, fueled largely by China's demand for resources, and further rate rises are expected from its central bank this year to keep inflation in check.
New Zealand interest rate futures prices rose and swap yields were up to 8 basis points lower as investors scaled back expectations of future central bank rate rises. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ ^ For a table on GDP details
For an instant view from economists
For a graphic on NZ GDP and official cash rate
http://link.reuters.com/ven94p ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ ^
BUMPY ROAD
Finance Minister Bill English said the economy was growing but the outlook is bumpy.
"I expect some volatility in the next few quarters of GDP data," he said.
Growth in the quarter was driven by house building and forestry, but the gains were offset by manufacturers running down inventories at the fastest rate in five quarters, while drought dented agricultural production.
Rising exports, led by strong commodity prices for dairy and wood products, supported growth with solid demand from two key trading partners, Australia and China.
Consumers have been cautious about spending in the face of slow wage growth and a rise in unemployment, which has also dampened business confidence.
A 7.1 magnitude quake in the country's second biggest city Christchurch and surrounding area on Sept. 4 is set to cast a further shadow over the economy's near-term outlook.
The Treasury department has estimated third-quarter growth will be cut by around 0.4 percent because of the quake, but rebuilding work will boost growth in next year and 2012 by 0.5 percent and 0.3 percent respectively. See
The uncertain outlook has prompted the RBNZ to scale back its growth forecast for the year to March 2011 to 2.8 percent from a 3.5 percent projection in June.
The bank left its cash rate unchanged last week amid a soft economic outlook and said future rate rises would probably be slower than previously expected.
All 18 economists polled by Reuters expect the bank to hold rates at 3 percent at its Oct. 28 review, with the consensus that the next rise will be in the first quarter of 2011.
Reflecting the tepid recovery and weak growth data, the amount of tightening seen over the next 12 months fell to 54 basis points from 66 basis points.
New Zealand-based Fonterra lifted some gloom from the market, however, as the the world's largest dairy exporter raised its final payout to farmers for the year to July and maintained its 2010/11 forecast. (Editing by Kim Coghill)