Charts of New Zealand interest rates from 90 days to 10 years all show a dramatic plunge in yields over the last four months. The momentum, direction and sentiment remains firmly downwards with latest projections of the global economy heading into recession in 2009 adding to the lower trend.

The local money markets are in a state of confusion and distortion as to where wholesale and retail deposit and lending rates will settle as the Government guarantee applies to deposits but not to the banks' wholesale borrowing. Whether 90-day wholesale interest rates decrease to 6.00%, 5.50% or 5.00% in 2009 comes down to your view on how the NZ economy will behave.

The market is convinced that the RBNZ will cut the OCR by 1.00% this week and another 0.50% reduction by Xmas or early in the New Year. However how the economy plays out in 2009 will determine just where the bottom in short-term interest rates will be.

I see the following three scenarios all having a chance to a greater or lesser degree:-

- Scenario 1 (60% probability)
90-day interest rates go no lower than 6.00% in 2009 as our agricultural export commodity prices do not fall much further and the rural sector receive a major boost from the lower NZ dollar value. Under this scenario, GDP growth starts to lift up by mid-2009 through a combination of increased primary production and good prices. This scenario requires global food prices to stay at current levels and not fall as consumer demand weakens in western economies. The RBNZ will not be justified in setting monetary policy at "loose" as the stronger GDP growth outlook in 2009 will not allow CPI inflation forecasts below 1.00%.

- Scenario 2 (30% probability)
90-day interest rates reach a low of 5.50% in 2009 as the current NZ economic recession extends into 2009. Export commodity prices fall further, not providing the lift to rural incomes and confidence as seen in Scenario 1. The RBNZ are required to move to a partial stimulus stance with monetary policy. Global oil and food prices fall to lower levels than current, allowing the CPI inflation rate to return to below 2.00%. Consumer and business confidence remain at low levels in 2009 with no improvement in housing and retail markets.

 Scenario 3 (10% probability)
90-day interest rates hit a bottom of 5.00% as the RBNZ deliberately introduce "loose" monetary settings. CPI inflation forecasts are below 1.00% as the economic recession deepens and no-one can see any way out. Globally, the economic recession deteriorates and central banks slash interest rates to even lower levels in an attempt to stimulate consumer spending.

I am often asked how the political/election outcomes in NZ and the US in early November will impact on the above scenarios and thus interest rate movements. I would expect a change here in NZ to a National-led coalition government will lift business confidence and investment. However the fate of the economy in 2009 is much more dependent on those key international commodity prices than the election result.

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*Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com