KEY POINTS:
The Reserve Bank has "plenty of room" to lower interest rates, says governor Dr Alan Bollard, as the economy braces for one of the biggest shocks ever to hit it.
"It is very clear that from an international financial point of view it is the worst shock since the Depression and we have all been surprised at the vulnerability of the system internationally," Bollard told the Herald yesterday.
"But so far as the world economy is concerned it is looking nothing like its worst hit, nothing like the 1930s."
Early relief on interest rates now looks likely. With a high official cash rate of 7.5 per cent Bollard has more room to move than his counterparts overseas.
The financial markets are expecting a cut of a full percentage point in the official cash rate when he reviews the rate next week, with possible future cuts to below the 5 per cent mark.
New Zealand Institute director David Skilling and NZX chief executive Mark Weldon have compared the shock New Zealand faces to the 1970s' double whammy of soaring oil prices and Britain's entry into the European Community.
And it hits an economy already in recession.
"It's a fair comparison to be thinking of the 1970s," Bollard said.
"But the fact is we don't actually know what it is doing to the world economy yet and it is very difficult to be analytical about where it ends up, in what size of overall shock."
Over the past 10 years New Zealand's trading partners have grown by around 4 per cent a year.
"They are now down to 3 per cent and forecast to go to 2 per cent."
During the Asian crisis 10 years ago trading partner growth fell to 1 per cent and in the nastier recession of the early 1990s to less than 1 per cent.
"Now will we get back to that? Not on the forecasts currently.
"I suspect the real answer to that is how well East Asia can hold up and it is too early to form a view about that."
A lot would depend on where commodity prices went.
"They have come off a little but not so much that it would really hurt our export returns in the short term," he said.
"The fact that the New Zealand dollar has come off is helpful too. It's bad for inflation, but it's very helpful on the export side."
The impact on trade is only one of the ways the international financial crisis will flow through to the New Zealand economy.
A tightening of bank credit is another.
Bollard said New Zealand banks on average drew about a fifth of their funding from the short-term commercial paper market offshore, which has frozen up. The Reserve Bank has moved to provide alternative sources of liquidity to the banks.
"Around the world we are seeing a massive deleveraging going on and a massive transfer of risk from the private sector to the governments."
With a high official cash rate of 7.5 per cent Dr Bollard has more rate-cut bullets in his bandolier than his counterparts overseas.
"We have plenty of room for monetary policy easing," he said.
The financial markets are expecting a cut of a full percentage point when he reviews the rate next week.
ANZ National Bank chief economist Cameron Bagrie believes Bollard will cut by a full point next week and again, by half a percentage point, in December and keep cutting next year until the OCR reaches 4.75 per cent.
With the rates banks lend at proving "sticky" at present, the Reserve Bank would need to move a lot to deliver relief to households' and businesses' cashflows, Bagrie said.
He also expects the kiwi dollar to fall to US55c from a bit under US60c yesterday.
BNZ economist Craig Ebert said: "We can be thankful the Reserve Bank, by way of its firm cash rate and supervisory role in the banking system, has leaned very well against the the sort of credit binge and shonky lending that has caused so much strife in other economies.
"As a consequence Governor Bollard has afforded himself a great deal more bullets to deal with an arguably lesser threat."
