Key Points:

How much more the Reserve Bank cuts interest rates will depend on how much worse the world economy gets, Governor Alan Bollard says - and the International Monetary Fund is warning that it is set to get a whole lot worse.

The IMF yesterday slashed its forecast for global growth this year to the weakest rate seen since World War II.

It expects the advanced economies, which include most of New Zealand's major trading partners, to shrink by 2 per cent, and to claw back only half of that next year.

And with growth in China and other developing countries expected to fall sharply, overall world growth is forecast to be a scant 0.5 per cent this year, rather than the 2.2 per cent the IMF expected just two months ago.

The International Labour Organisation said that global unemployment and poverty are set for a dramatic increase in the coming year. The UN agency added that in a worst-case scenario, recorded unemployment could rise by more than 50 million from 2007 levels to 230 million, or 7.1 per cent of the world's labour force, by the end of this year.

The IMF's downbeat view found agreement among the elite financiers and economic thinkers gathered at the World Economic Forum in Davos, Switzerland.

Nouriel Roubini, professor of economics at New York University, said: "There is nowhere to hide. We have for the first time in decades a global synchronised recession. This is not your traditional minor recession."

Dr Bollard yesterday continued his pattern of delivering all the interest rate relief the financial markets were looking for - and then some. He cut the official cash rate from 5 to 3.5 per cent, an all-time low, bringing the cumulative reduction since July to a hefty 4.75 percentage points.

He said the aggressive rate cut reflected international factors: the fact that the global economy was now in recession, the worsening outlook for exports and commodity prices, and tight conditions in credit markets.

The IMF forecasts world trade to shrink by nearly 3 per cent this year, compared with growth of 4 per cent last year and 7 per cent in 2007.

Fonterra's suppliers are not alone in facing lower incomes: the IMF expects non-fuel commodity prices to fall 29 per cent this year.

The trade balance remains in the red - by $5.6 billion over 2008 - Statistics New Zealand reported yesterday.

NZ imported $1.11 worth of goods for every $1 of exports in the last three months of 2008. But at least the gap is shrinking: it had been $1.14 in the September quarter.

Dr Bollard left the door wide open for more OCR cuts, which would depend on developments in the global economy, and on how New Zealanders responded to the stimulus measures already in place.

The combination of lower interest rates, a lower dollar, tax cuts and increased government spending would boost growth, he said, but only if households and businesses did not reduce their spending unnecessarily.

He also called on the banks to pass on lower wholesale interest rates to their customers. Borrowing by New Zealand households grew just 4.2 per cent in 2008, the weakest growth since at least 1991.

Dr Bollard said New Zealanders were responding with an appropriate degree of caution to the tougher environment, without going overboard.

"The New Zealand economy does need to save more but it doesn't need to do it in a massive move at the expense of consumption. We are not unhappy with what we are seeing."

The IMF's forecasts imply that economic activity in the rich world by the end of next year will only be back where it was at the start of last year.

Even the modest recovery it expects next year would depend on governments taking prompt action to clean up the banks and financial system more generally, it said.

Right now they are in no fit state to enable an economic recovery, in its view.

"Notwithstanding public injections of capital, banks around the world may have an insufficient capital cushion to weather a deep global economic downturn," the IMF said.

With further writedowns to come, US and European banks would need at least US$500 billion (nearly $1 trillion) of new capital just to prevent their capital position from deteriorating further.

Governments' responses so far had not stemmed concerns, the IMF said.

Dr Bollard repeated earlier assurances that New Zealand banks are sound and have avoided the kinds of lending that got their Northern Hemisphere counterparts into trouble.