The Reserve Bank of New Zealand is giving a meltdown in Europe a one-in-ten-chance where multiple nations are forced out of the economic bloc and global funding markets freeze up.
Governor Alan Bollard told Parliament's finance and expenditure committee there's a 10 per cent chance of countries on the periphery of the euro-zone exiting the bloc and toxic Spanish and Italian debt seeps into European powerhouses France and Germany.
"The real concern in both Europe and around the world is could a Greek exit spark off contagion through into other peripheral countries that are bigger and more important and where there's liabilities held by German and French banks, and I'm talking about Spain and Italy," Bollard said. "We think there's a small chance of that, but it's absolutely a real chance."
Europe's debt woes have left global financial markets in a fug this year after more of the so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain) put their hand out for a bailout amid unsustainably high borrowing costs.
Last week, Spain was given the thumbs-up for a 100 billion euro package to shore up its banking system.
The yield on Italy's 10-year government bond rose almost 2 basis points to 6.23 per cent, while the yield on Spain's benchmark note fell 1 basis point to 6.76 per cent.
The yield on Greece's 10-year bond dropped 35 basis points to 28.59 per cent, and the yield on Portugal's 10-year debt fell 11 basis points to 10.7 per cent. The yield on Ireland's 10-year government debt fell almost 5 basis points to 7.4 per cent.
Financial markets are now awaiting Greece's second general election this weekend after the first failed to deliver a Parliament that could form a government, and there are fears the Mediterranean nation may quit the euro-zone rather than embrace harsh budget cuts.
The central bank's base-case scenario, where the region will "muddle through" its current situation, has a 60 per cent chance, and a Greek exit from the euro-zone is rated a 30 per cent chance, Bollard said.
The central bank is watching Europe closely, and if things seriously deteriorate and funding markets freeze up, it would look to re-introduce the liquidity facilities it made available during the global financial crisis, Bollard said.
In terms of freeing up trading markets, the central bank is in "a reasonably comfortable position" to cut the official cash rate from its record low 2.5 per cent, though "we're not planning to do that at the minute," he said.
New Zealand does not have much direct exposure to Europe, with just 7 per cent of the nation's exports going to the euro-area. Where the biggest trade risk lies is through its Asian trading partners, which have a greater contact to Europe and may have to cut back on buying New Zealand products.
Bollard kept the benchmark interest rate on hold, and trimmed the bank's forecast for the 90-day bank bill rate, often seen as a proxy for the OCR, with the rate unchanged at 2.7 per cent until June 2013, before peaking at 3.4 per cent in March 2015. It had previously expected the rate to rise in December this year.