KEY POINTS:
ANZ National Bank economists' view of the economic outlook has darkened, in part because of concerns about the finance company sector.
They now expect the Reserve Bank to start cutting interest rates in March next year.
Previously they thought it would be late next year or early 2009
before the easing began.
Chief economist Cameron Bagrie said the economy was at a very vulnerable stage of the cycle.
In particular there had been a prodigious increase in household debt since the start of the decade.
But now the international environment was more uncertain.
Global financial markets' volatility reflected a reassessment of risk and New Zealand was heavily indebted and reliant on offshore capital, he said.
"At this stage global unease remains contained to the United States and the Federal Reserve has moved quickly to shore up confidence and provide support," he said.
"However we expect financial markets to remain volatile."
Within New Zealand credit conditions have tightened at a time when the housing market and consumer spending are already showing signs of easing.
"We can no longer ascribe a zero probability to recent signs of dislocation across non-bank financial institutions turning into a systemic issue," he said.
"This is despite the financial system being fundamentally strong.
"The experience of the US shows that events do tend to escalate, particularly when investors' confidence disappears."
Tighter credit and easing house prices were likely to have a big impact on the economic cycle, Bagrie said.
"There has already been $1 billion of savings put at risk by various finance industry-related collapses over the past year. There is speculation of more to come." The flow-on effects on confidence would, at the very least, bring reduced lending from the sector which has helped to fuel consumer spending, especially on durable goods, in the past few years, he said.
Consumption has also been turbocharged by the wealth effect from rising house prices.
And highly leveraged property investors are critically reliant on rising house prices, given the gap between interest rates (about 9 per cent) and rental yields (about 4 per cent).
"Households have shown remarkable resilience so far in the face of rising interest rates.
"[But] we are in uncharted territory when looking at the debt servicing burden, which has reached unprecedented levels of close to 14 per cent of disposable income."
Bagrie is expecting three cuts of 25 basis points to the official cash rate in March, April and June next year.