BUSINESSDESK: The Reserve Bank is giving a meltdown in Europe a one-in-10 chance, where multiple nations are forced out of the economic bloc and global funding markets freeze up.
Governor Alan Bollard told Parliament's finance and expenditure committee there was a 10% chance of countries on the periphery of the eurozone exiting the bloc and toxic Spanish and Italian debt seeps into European powerhouses France and Germany.
"The real concern in both Europe and around the world is could a Greek exit spark off contagion through into other peripheral countries that are bigger and, more important, where there's liabilities held by German and French banks. I'm talking about Spain and Italy," Dr Bollard said.
"We think there's a small chance of that, but it's absolutely a real chance."
Europe's debt woes have left global financial markets in a fug this year after more of the so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain) put their hand out for a bailout amid unsustainably high borrowing costs.
Last week, Spain was given the thumbs-up for a 100 billion euro package to shore up its banking system.
The yield on Italy's 10-year government bond rose almost 2 basis points to 6.23%, while the yield on Spain's benchmark note fell one basis point to 6.76%.
The yield on Greece's 10-year bond dropped 35 basis points to 8.59 percent, and the yield on Portugal's 10-year debt fell 11 basis points to 10.7%. The yield on Ireland's 10-year government debt fell almost 5 basis points to 7.4%.
Financial markets are now awaiting Greece's second general election this weekend after the first failed to deliver a Parliament that could form a government, and there are fears the Mediterranean nation may quit the eurozone rather than embrace harsh budget cuts.
The central bank's base-case scenario, where the region will "muddle through" its current situation, has a 60% chance, and a Greek exit from the eurozone is rated a 30% chance, Dr Bollard said.
The central bank is watching Europe closely, and if things seriously deteriorate and funding markets freeze up, it would look to re-introduce the liquidity facilities it made available during the global financial crisis, Bollard said.
In terms of freeing up trading markets, the central bank is in "a reasonably comfortable position" to cut the official cash rate from its record low 2.5%, though "we're not planning to do that at the minute", he said.
New Zealand does not have much direct exposure to Europe, with just 7% of the nation's exports going to the euro-area.
Where the biggest trade risk lies is through its Asian trading partners, which have a greater contact to Europe and may have to cut back on buying New Zealand products.
Dr Bollard kept the benchmark interest rate on hold, and trimmed the bank's forecast for the 90-day bank bill rate, often seen as a proxy for the OCR, with the rate unchanged at 2.7% until June 2013, before peaking at 3.4% in March 2015.
It had previously expected the rate to rise in December this year.