KEY POINTS:
Michael Cullen has emptied the piggy-bank in a bid to mitigate the severity of the economic slowdown.
After running Budget surpluses in the range of 3 to 6 per cent of gross domestic product during the good times of the past six years, he has now slashed them to well under 1 per cent over the next four years.
That is between $3 billion and $3.5 billion a year less than forecast in December.
Having halved Government debt since 1999, relative to the size of the economy, he is now able to increase Government borrowing by around $3.5 billion a year over the next four years, which will stabilise it around the 17.5 per cent of GDP level.
The result is a fiscal stimulus equivalent to 2.3 per cent of GDP over the 2008/09 year, which Treasury (and other) forecasters expect to be the trough of the economic cycle.
It is the biggest hit of fiscal adrenaline we have seen since 1997 and what the Reserve Bank makes of it should be clear at its next interest rate review on June 5.
The Treasury's forecasts don't have interest rates or the dollar falling until early next year.
But the exchange rate has already been easing for several weeks as the financial markets have looked at the weakness of recent data and concluded the bank will have started cutting rates by the end of September.
The dollar jumped by more than a cent against the US dollar in response to the Budget and debt markets rallied.
They still expect interest rates to be a full percentage point lower by this time next year, according to Credit Suisse's swaps-based indicator. But pre-Budget market pricing implied rates would be 1.2 per cent lower in a year's time
The combined effect of a feeble housing market, flatlining retail sales, shrinking employment, and the deferring of the emissions trading scheme's impact on petrol prices gives the Reserve Bank more leeway.
Even so, the Treasury forecasts inflation, currently 3.4 per cent, will get worse before it gets better - peaking at 3.7 per cent in September and not falling back inside the bank's target zone of 1 to 3 per cent until the June quarter next year. That allows for deferring the ETS impact on transport fuels, which is estimated to push up the consumers price index by 0.4 per cent, from next year to 2011.
The Treasury has cut its forecasts for economic growth over the next two years to 1.5 and 2.3 per cent respectively, from 2.1 and 2.8 per cent last December.
It thinks the economy contracted slightly in the March quarter but it forecasts a return to positive growth in the current quarter, avoiding a technical recession.
The lower growth outlook reflects a sharper-than-expected slowdown in the housing market, the summer drought and the fallout of the US financial crisis on the world economy.
House prices, which had almost doubled since 2002, are expected to fall about 6 per cent over the coming year. The global credit crunch has driven up the banks' cost of funds, confronting borrowers with stiff increases as their fixed-term loans roll off.
Last month's rains have eased the drought situation, Treasury says, but it will still affect next year's agricultural production, while electricity generation this winter remains to some extent hostage to rain that has yet to fall.
On the positive side the personal tax cuts announced yesterday are expected to provide an underpinning to consumer spending during a period when households are feeling the double whammy of high interest rates and falling house prices.
The labour market is expected to weaken but remain relatively tight, with unemployment creeping up towards 4.5 per cent by 2011.
Wages are expected to grow about 1.5 per cent a year faster than inflation, on the assumption that labour productivity growth will average 1.8 per cent a year.
The Treasury expects the terms of trade - relative prices for the kinds of things New Zealand exports compared with the kind of things it imports - to keep most of their recent gains and remain high by historical standards.
Dairy prices may have peaked but world prices for meat and non-commodity exports are expected to rise.
The current account deficit is expected to drop only briefly below 7 per cent in the short term as the credit crunch raises the cost of servicing New Zealand's high level of overseas debt.
