Prepare for pain in the pocket

Householders should brace for prolonged pain as power and petrol prices rise, and with little relief in sight from punishingly high mortgage rates.

On a day of gloomy economic news yesterday:

The Reserve Bank refused to hold out hope of a drop in interest rates till the second half of next year at the earliest, despite a housing slump and warnings of a deteriorating economy.

And it warned that higher interest rates were "the new reality" due to world events.

The Government unveiled its first operating deficit in 15 years - $394 million - after falls in world stock markets contributed to a $4.2 billion turnaround in the forecast headline surplus.

It was revealed a drop in tax revenue, $700 million below forecast, will not affect the Government's plans for tax cuts - but they may have to be phased in more slowly.

There was some good news - the economy is expected to keep growing by around 2 per cent a year for the next three years.

The Reserve Bank said there was potential for an even more severe downturn in house prices, however, bringing an end to the spending spree that has helped to push up inflation in recent years as home owners borrowed against rising values. There are signs that is already happening.

Finance Minister Michael Cullen warned that the Government might have to tighten its belt as well, but reiterated that his tax cuts would go ahead in the next Budget. He said there would be no cuts to social spending.

The biggest hit on the Government's books was a $2.5 billion paper loss on government investments during the global sharemarket downturn. There was also a $1 billion paper loss on revaluations of ACC liabilities.

Dr Cullen said the figures were significant and should not be "brushed aside", but they did not affect the Government's ability to deliver a strong Budget in May.

They involved long-term investments, including those by the $14 billion Cullen super fund, which could ride out the global uncertainty.

The fall in expected tax revenues was a bigger concern to the Government and it was monitoring the situation "very carefully".

"We are living in a period at the moment of quite considerable uncertainty," Dr Cullen said.

It meant the Government might have to be "a little bit more careful around the phasing of the [tax cut] package".

With any tax cuts expected to be modest, some gains could be wiped out by higher petrol prices.

The emissions trading scheme, due to come on-stream next year, could add seven cents a litre to petrol prices in 2009 and push up power prices by 7 per cent in 2010, according to the Reserve Bank.

But Dr Cullen said yesterday the scheme could not be delayed.

Fuel companies said unleaded 91 and 95 petrol could cost New Zealanders more than $2 a litre next year, and diesel was expected to rise to over $1.50 a litre, in part because of new taxes and biofuel regulations.