Tony Alexander, Chief economist at the Bank of New Zealand.

This is very important to ourselves because as long as the United States housing market keeps weakening financial institutions over there will have to write larger and larger losses. That means investors will remain very cautious about putting money into financial institutions and that impacts upon us in New Zealand in a number of ways.

One way is that because United States banks have major difficulty getting money to lend out they are having to cut back their lending. That is generating extra weakness in the US business sector, motor vehicle industry, and of course housing. A similar situation is occurring in the United Kingdom and that means prospects for overall world economic growth are continuing to deteriorate.

That hits us through commodity prices being lower than would otherwise be the case, reduced tourism inflows, and generally lower demand for manufactured. It also affects us through higher interest rates than would otherwise be the case. We New Zealand banks have to get about one third of the money we lend to our customers from foreigners. We can still get that money but the cost has risen tremendously over the past year and there is as yet no sign that the extra cost is going down.

The best way to think of this is like the raw material cost for us banks rising just as the raw material costs for a steel roofing manufacturer have gone up in New Zealand. If one makes some rough calculations it works out that interest rates in New Zealand are probably around 0.75% higher than would be the case without the international credit crisis.

Perversely however just as global economic conditions have deteriorated and prospects for growth in the coming year worsen business and consumer sentiment levels in New Zealand have shot through the roof. The One News Colmar Brunton poll for instance recently showed a net 23% of consumers expecting the economy will get better over the coming year. The reading for this survey a month earlier was just positive 6% and back in April when the Kiwi dollar was near 82.0 US cents and fixed interest rates were at almost 10% the reading was -34%.

People have probably been reacting positively to falling interest rates, the falling exchange rate, some decreases in petrol prices, anticipation of tax cuts, and perhaps the wet winter ending. But no one should expect that just because confidence levels have improved people will be opening their wallets much in the near future. Household budgets are severely constrained by high food and petrol prices and business ability to spend on new employees and equipment is constrained by very tight cash flows and low ability to increase selling prices.

This means that although we think the recession in New Zealand has ended with growth likely to be recorded over the December quarter, our economy’s performance over the next 12 months is still likely to be relatively muted. House prices are likely to fall further while the unemployment rate will likely rise from 3.9% to around 5%. But as noted earlier, interest rate and the exchange rate are going down and we know these developments will eventually produce stronger growth in New Zealand. Our pick is that such stronger growth will not truly appear until late 2009 at the earliest. That forecast is based upon an assumption that the financial bailout package in the United States leads to an improvement in the housing market over the coming year.