Opinion: Bernard Hickey points to 5 financial fault lines to watch over Summer that may shake NZ's economy over 2012 and 2013

By Bernard Hickey

There's nothing better than a quiet summer away from the email and the constant chirpping of the mobile phone.
Particularly after the last year of tectonic shifts in the world of finance and geography, New Zealanders could do with a break.

But those with an eye on matters financial may not get much of a rest over the summer months.

Major events could change the outlook for New Zealand's economy dramatically and they could happen when New Zealanders are dozing off on the verandah after a long day in the sun.

Here's the 5 financial fault lines to watch:

1. The failure of a major European bank or banks.

Europe's banking system is suffering severe stress. The spreads measuring the cost of swapping euros into US dollars are near record highs. Banks are having to borrow record amounts from the European Central Bank because they have stopped trusting each other.

Investors are worried the huge amount of Southern European government bonds sitting on the balance sheets of French, German, Spanish and Italian banks are not worth as much as they used to be.

Banking regulators told Europe's banks to raise 115 billion euros this month to strengthen their balance sheets. Many will struggle to raise it from their shareholders and may have to ask for government bailouts. The problem is many governments can't afford this either and are struggling to borrow money from their own bond markets.

These problems in the European banking system and the European bond markets are creating a toxic and dangerous series of negative feedback loops that is driving interest rates higher, slowing economies, blowing out budget deficits and further weakening bank balance sheets.

2. The European Central Bank may be forced to print money.
Banks, markets and many investors are both begging for and praying that the European Central Bank (ECB) will print money to buy European bonds, helping to support prices and keep interest rates low. The trouble is it is legally unable to buy European government bonds in a wholesale way and the German central bankers on its board are implacably opposed to such money printing because they are worried about inflation.

But if the European banking system threatens to unravel, as it has done a couple of times already over the last three months, then emergency measures may be adopted. If the ECB does print and buy then markets should calm down and the European economy may pull out of its death spiral of deleveraging and austerity.

3. China may choose to loosen policy and go on another building spree
China's decision in late 2008 to go on a lending and spending spree inside its own economy helped cushion the blow of the Lehman crisis for the New Zealand economy. It spent massively on construction, boosting iron ore and coal prices, which in turn supported the Australian and New Zealand economies.

There are signs now of a rapid slowdown in the real estate and manufacturing sectors in China. Many are waiting for the government to intervene again, although there are some doubts because inflation remains dangerously high.

4. Australia's housing market slides dramatically
The Christmas/New Year break may be very difficult for real estate agents in Sydney, Melbourne, Brisbane and Perth. Prices are already cooling rapidly and both lending and sales have slumped in recent months. Australia's economy is now on two tracks. The mining sector is experiencing an historic investment boom, but retailing and manufacturing are struggling under the weight of a high

Australian dollar and high debts underpinned by high house prices. Falling house prices would rapidly cool the Australian economy and demand for New Zealand's manufactured exports, which have done well in recent years.

5. New Zealand's budget may need to be tightened
A more rapid slump in the European, Chinese and Australian economies, along with a slow rebuild in Christchurch, would force the government to reevaluate its path to surplus by 2014/15. The new government will either have to choose to delay the return to surplus or cut deeper into public spending.

On second thoughts, maybe we should all turn our phones off for a long, long time. Or at least until the Christmas turkey has been digested.