KEY POINTS:
The country ended 2007 with some respectable numbers on its economic report card.
The economy expanded 3.3 per cent in the year ended September, while inflation over the same period was 1.8 per cent.
The unemployment rate is 3.5 per cent, a record low.
The terms of trade - relative prices of the kinds of things we export compared with the kinds of things we import - are the most favourable since 1974.
The Government's coffers are overflowing.
But the outlook is less rosy than these numbers would suggest. On a quarterly basis growth peaked back in March.
The economy expanded as much in the first half of 2007 as it had over the previous year and a half.
But it has slowed markedly since then as households, whose consumption represents more than 60 per cent of economic activity, battle higher mortgage rates and global inflation in oil and food prices.
The consensus among economic forecasters is that private consumption growth will run around 1.6 or 1.7 per cent through 2008 and 2009, the weakest rate since 2000.
That is in spite of household incomes being underpinned by brisk wage growth, the prospect of tax cuts and a tsunami of dairy cash.
The problem is that the necessities of life - housing, food and energy - are gobbling up a larger share of people's incomes, leaving less to spend on other things.
The housing market has flipped from one in which house prices were climbing and borrowing costs were low to one where house prices are flatlining but borrowing costs are rising.
After doubling over the the previous six years house prices, as measured by the Real Estate Institute's national median, have been going sideways since May.
But the long boom has pushed the average house price to six times the average household disposable income, nearly twice its long-term average.
Households with mortgages are consequently carrying much more debt relative to their incomes than they used to and are more exposed to interest rates.
And with fear and suspicion now the dominant sentiment in international credit markets, the days when New Zealand banks could tap cheap money offshore to fund home loans are over.
Two-year fixed mortgage rates are now the highest they have been for nearly 10 years.
The average mortgage rate being paid is around 8 per cent, the highest since October 1998, and the Reserve Bank expects it to approach 9 per cent by 2009.
About 30 per cent of all fixed-rate mortgages, representing a quarter of all mortgage debt, come up for an interest rate reset over the next 12 months. At currently available mortgage rates these borrowers will face increases of 0.7 to 1.5 percentage points.
Meanwhile the plateau in house prices is expected to turn off a phenomenon which has turbocharged the domestic spending side of the economy in recent years: the wealth effect.
That is when people borrow and spend some fraction - a few cents in the dollar - of the increase in the value of the equity in their homes, allowing spending to grow faster than incomes.
The biggest new factor on the positive side of the income ledger is the prospect of a bumper dairy payout.
It will pump about $4 billion more cash into the economy than last season, says Westpac chief economist Brendan O'Donovan. And it will all get spent, he believes.
While some farmers will take the opportunity to reduce their debt, others will borrow to expand their operations. Rural land prices have already risen sharply as farmers do what they always do and capitalise improved returns, O'Donaovan says.
"In aggregate they won't be paying down debt, they will be leveraging up."
But it takes time for higher farm incomes to flow through the rural towns to the big cities.
And every silver lining has its cloud.
The global "agflation" that is boosting dairy farmers' incomes is also making trips to the supermarket an increasingly expensive business.
Likewise the tightness of the labour market underpinning wage growth is partly because of a dwindling of net migration inflows as a widening income gap lures more and more New Zealanders across the Tasman.
The Reserve Bank forecast inflation to be above 3 per cent all through this year.
Crucially, it also expects it to remain in the top quartile of its target band of 1 to 3 per cent through 2009 as well, even with interest rates and the dollar remaining at their current elevated levels.
Those projections assume $1.5 billion worth of tax cuts, which may well prove to be on the low side, and do not include the impact of the emissions trading scheme on transport fuel costs from the start to 2009.
This makes for an environment in which the central bank has little"headroom" to accommodate further upward pressure on inflation.
Yet the international environment might deliver just that.
The global credit crunch could well get worse before it gets better.
If 2007 is anything to go by, when global risk aversion goes up the kiwi dollar goes down and investors lose their appetite for the carry trades which underpin the exchange rate.
That might be blessed relief for exporters but it pushes up the cost of imported goods.
The biggest uncertainty overhanging the economy in 2008 is how the global credit crunch, arising from the US sub-prime mortgage crisis, will play out. Rising global interest rates would be bad news for us, a country up to our neck in debt.
