Tony Alexander Chief economist at the Bank of New Zealand.

The Reserve Bank has finally started cutting interest rates and we expect at each review of the cash rate over the next few months they were cut by 0.25%.  Ultimately the cash rate, which is now at 8%, is likely to get to 6% late next year with a possibility that it goes as low as 5.5%. 

The chances of this low interest rate a year from now, unfortunately, appear to be increasing as each week goes by.  The news regarding the international credit crisis continues to get worse with more financial institutions around the world reporting losses associated with the decline in the US housing market.

In addition, forecasts for growth in our trading partners continue to get revised down slightly, and housing market conditions in economies such as the United Kingdom, Spain, and Ireland continue to deteriorate sharply. 

Even across in Australia there are signs of weakening although interestingly because they had a cyclical pullback in their housing market about three years ago the extent of their housing downturn is quite mild so far.  But one would have to be cautious about what is going to happen in the near future as consumer confidence is near a 16 year low in business.

Here in New Zealand the drought broke some time ago and the country is now awash literally with excess water.  The effects of the summer drought will linger for up to three years according to some of the agricultural experts but the good news for the farming sector and those involved in it is that with interest rates going down even though world growth prospects don’t look so good for the next couple of years, the New Zealand dollar is declining.

At the time of writing the Kiwi dollar was trading just below 74.0 US cents, which is well down from the record high above 82.0 US cents set in March. 

Over the coming 18 months as interest rates decline in New Zealand but get increased in the United States – over 2009 – the interest rate advantage to investors of buying and holding New Zealand dollars will rapidly diminish. 

In addition some investors are going to be scared off by the weakness in our economy – although having said that there are plenty of investors offshore looking enviously at New Zealand’s good prospects for the next 50 years on the basis of rising incomes and emerging economies, rising world population, and shortages of food products overseas.

We think that because there is this awareness offshore of how our economy in future years will be underpinned by the primary, food and beverages sectors the extent of the cyclical pullback in the Kiwi dollar will be limited. 

At this stage we couldn’t justify a forecast that the Kiwi dollar would be trading below 60.0 US cents this cycle but history shows this is quite possible.

Against other currencies the Kiwi dollar has also depreciated in recent months most notably against the euro, which has gained strongly against the greenback over the past few years.  We expect further depreciation against the euro and the British pound and this is very important for the red meat sector. 

Meat prices are rising strongly from year ago levels which is something we have been expecting for some time on the basis of declining stock availability and increasing demand for protein offshore.

Perhaps a good way for people to think about what is happening with our economy at the moment is that it is a very long overdue rebalancing away from a debt fuelled consumer spending binge toward a more sustainable export led position. 

Of relevance is the fact that exporters still in business after five years of an overvalued exchange rate are likely to be highly inefficient so currency falls will quickly feed through to the bottom line.  Having said that, raw material prices continue to increase strongly and a falling currency will further boost these costs so a very close eye needs to be kept on cash flows.

And finally, keep an eye out for good staff.  The easing in the labour market currently underway is merely cyclical and not structural. Small farm operators seeking staff may now be able to attract some people to the countryside whereas a year ago it would have been very difficult.