KEY POINTS:
The economy will go into recession in the second half of this year, the Bank of New Zealand says, as the housing market downturn and the global credit crunch form an unpleasant cocktail.
The bank's head of research, Stephen Toplis, said it would be a very mild recession - two successive quarters when the economy shrank by 0.1 per cent.
"It's margin-of-error stuff. But never mind the semantics. Would it really feel any different if it turns out the economy grows by 0.2 per cent over that period?"
A homeowner facing a steep rise in mortgage rates or a business with an empty order book will not take any comfort if a technical recession is avoided.
The BNZ is the first major economic forecaster to use the "R" word.
"A lot of New Zealanders are in complete denial. The fact of the matter is the economy is very poorly and will stay that way for some time to come," Toplis said.
New Zealand was only starting to feel the effects of the global credit crunch, he said.
It means a widening risk premium built into interest rates, which will be there whether or not the Reserve Bank sees fit to lower its official cash rate.
Toplis said banks funded anything from a quarter to a half of their lending from overseas sources, and the cost of those funds was moving up dramatically.
At the same time some business borrowers who might in normal times access wholesale markets directly were drawing down their stand-by lines of credit with the banks.
For some borrowers, such as property developers, loans could become unavailable at any price as the banks rationed credit, he said.
As well as higher interest rates households face higher prices for essentials: food, petrol, electricity and local body rates. As the cost of living rises there is less to spend on other things and businesses which chase the discretionary dollar will feel the pinch.
Meanwhile house prices are already 4 per cent down on their peak and the BNZ expects to see double-digit falls before it is all over.
House sales are down by a third on a year ago, while the average number of days it takes to sell is up from 32 a year ago to 50 - the highest level in six years.
There are positive influences however.
Wages are growing at the fastest rate for years, the unemployment rate is low and tax cuts are in the offing. Plus businesses are expected to keep investing. But Toplis believes these factors are only enough to prevent a deeper recession.
The bank's forecasts assume $1.5 billion worth of tax cuts. They may turn out to be bigger, but they may also be smaller or later than people expect, as signs are emerging that tax revenue will be lower than forecast.
The labour market is the last part of the economy to benefit from an upturn or to suffer in a downturn.
Toplis said the tight labour market could mean that inflationary pressures would take longer to dissipate than people assumed.
If so it would be longer before the economy was released from the grip of high interest and exchange rates.
The Reserve Bank's mandate is to keep inflation down, not growth up.
"The danger is that the easing when it comes is through a drop in the exchange rate. If so interest rates will stay higher for longer."
On the export front, forecasts of world economic growth this year have been dialled back sharply.
The terms of trade - prices for the kinds of things the country exports relative to prices for the kinds of things it imports - are the most favourable since 1974.
But prices are one thing, volumes another, Toplis said.
