ANZ Economic Outlook

The world has changed since our February edition. Conflict in the Middle East has seen fuel prices at the pump surge and economic confidence tumble – and has seen forecasters and policymakers alike talk less about their forecasts and more about the risks around them. In this environment, consideration of potential scenarios is more important than focusing on the false precision inherent in a central forecast. In times like these, assumptions are doing a lot of the work, and small changes in them can generate very different paths for inflation, growth and policy. That was a lesson from COVID: most forecasters missed the turning points, but the value came from being explicit about scenarios and sensitivities.

On balance, data since our November edition have landed on the hawkish side of expectations, with Q3 GDP and Q4 CPI both stronger than expected. And that’s prompted financial markets to tighten monetary conditions without the RBNZ lifting a finger: the NZD has appreciated, and short end interest rates have moved higher in anticipation of a more aggressive hiking cycle. The latter is now feeding through into rising fixed mortgage rates. We recently brought forward our call for the timing of the first OCR hike to December 2026 and would characterise risks as skewed to earlier than that.

As outlined in the previous section, the starting point for economic momentum is a little stronger than we were anticipating three months ago. However, the finish line has not moved very much. Data over late 2025 and early 2026 have confirmed that the New Zealand economy has picked up speed, with GDP, inflation and a range of high-frequency indicators all printing on the firm side. Taken together, this combination suggests the recovery needs to settle into a more sustainable pace if inflation is to be kept in check. Given that financial conditions have tightened, there is still meaningful spare capacity in the labour market, and housing market momentum is muted, we think that moderation is likely to occur.

After what feels like a long cold winter, signs of a spring thaw are emerging across the New Zealand economy. GDP growth was significantly weaker than expected in Q2, but as we’ve been noting from the get-go, a lot of that weakness can be teed up to volatility and quirky seasonality. Looking through the noise, we’d characterise economic momentum as travelling broadly sideways over the first half of 2025: weaker than both our and the RBNZ’s prior expectation. 

As we outlined in the previous section, conditions appear to be in place for a recovery back to full employment. Our forecast is that the easing delivered to date and one more 25bp cut in November (combined with a signal to ease more should the data warrant) will be enough to make that happen.

We’re now a few months on from US President Trump’s “Liberation Day” tariff announcements, but the dust is only just beginning to settle – and of course, we’re only ever one new tariff announcement away from it being kicked up again. Global markets appear to be betting on a relatively contained fallout, but the jury is still out as regards to what it all means for global trade and growth. US tariffs haven’t been this high since the late 1930s, and the global economy is a very different place than it was back then: uncertainty is set to linger for a long while yet. 

Despite a souring in the high-frequency data recently, we remain optimistic that we are on route towards recovery, even if it is a little delayed. It is a relatively gradual recovery from a low base (meaning it doesn’t feel like much) but further monetary easing should make it happen. In fact, we think we’re now potentially past peak pessimism, with some of the early data for Q3 picking up (albeit not strongly) and the RBNZ’s August MPS signalling they are willing to provide a little more support than previously.

Global volatility has dominated the wires since our February edition, and while a lot of the initial panic following Trump’s “Liberation Day” announcements has subsided, the world is still a different place: a 10% minimum tariff rate on all goods exported to the US seems like the new base case for all economies, with China likely to face something higher than that once the dust has settled. 

It’s fair to say that over 2021-22 the New Zealand economy undertook an ambitious sprint that it wasn’t remotely in shape to handle. It was pulling muscles and popping the odd lung, while spectacularly overheating. In response, the RBNZ stopped handing out the energy drinks and instead added drag resistance with ever-higher interest rates until it came staggering to a stop – a compulsory breather in pursuit of low and stable CPI inflation. More than one sector has been flat on its back, but the good news is, it worked, and come 2025 the economy is starting to get back on its feet. And provided inflation pressures remain contained, the RBNZ should allow the economy to build towards a sustainable pace of expansion, a nice steady jog. If the economy falters (taking CPI inflation below target), the RBNZ will be ready with the sugar. If it bolts (pushing inflation above the target band) the RBNZ stands ready to slow it down once more. Setting the economy running at a steady pace that keeps inflation contained while achieving its best possible race result may require some policy recalibration down the track, particularly given global uncertainty, but for now, cutting the OCR to a non-restrictive level (currently assumed to be ~3%) and stepping back to watch the race is an appropriate strategy.  

The RBNZ has started withdrawing monetary restriction. Parts of the economy are responding to that, but it will take time for easier monetary conditions to be reflected in hard economic outcomes. Business confidence has lifted sharply, but activity and employment indicators for the here and now, while off their lows, are still soft relative to history. Auction clearance rates suggest the housing market is about to turn a corner, but there’s still plenty of data to suggest it is quite loose currently. Falling interest rates are expected to drive a recovery in economic growth towards trend, and an eventual improvement in labour market conditions. But there’s still a patch of soft momentum to navigate in the near term, and things will remain patchy for some time. The RBNZ is not on a preset path, and the data flow will determine the pace and extent of easing. We remain comfortable with our current forecast for the OCR to reach 3.5% by mid-2025.

Recent high-frequency data suggests the slowdown in the economy is broadening and gathering pace. But there is a risk in taking the full signal from these data, given that GDP, CPI and labour market data have all evolved broadly as expected. While interest rates are heading lower, there are still risks to the disinflation trajectory and the pace of policy easing remains uncertain. The uncertainty is brought about by the fact that by and large this downturn is policy induced. Unlike previous downturns, the economy hasn’t experienced a sudden confidence or income shock. Accordingly, as the RBNZ takes the handbrake off, there’s a risk that the economy bounces back faster, potentially threatening inflation’s descent to 2%. How much damage has been done from past tightening, and how this persists (particularly in the labour market) is likely to define the pace of easing.

Non-tradable inflation has surprised on the stickier side of expectations of late, suggesting the lags from monetary tightening are lengthier and/or tightening hasn’t quite gotten as much inflation-fighting traction as previously assumed. However, economic activity has been on balance weaker than expected and forward-looking indicators suggest things aren’t going to pick up any time soon. Indeed, key drivers of economic momentum such as housing, fiscal policy, net migration, and the terms of trade are increasingly playing ball in terms of the slowdown the RBNZ needs to see. Increasing coordination across these drivers could become particularly potent if amplified by households and businesses following through on their reported pessimism.

All up, the economy is on the right track for disinflation, but there are still unresolved questions about the speed of the train and whether the track leads all the way to 2% – or for that matter whether we’ll overshoot the station. Here and now, inflation is still way too high, and upside risks remain. That’s expected to keep the RBNZ in its watch, worry, wait stance for a while yet, standing ready to respond and recalibrate to data surprises in either direction. 

The economy has cooled, but there’s still a long descent to 2% inflation to navigate from here. High interest rates are cooling demand and have caused GDP data to look recessionary. However, despite the weakness, capacity pressures need to weaken further in order to get inflation sustainably back to 2%. It’s more challenging than usual for the RBNZ to calibrate its policy response, given the large shocks that are still buffeting the economy and old pandemic-era shocks that are still working their way through. Let’s dig into some key drivers in a little more detail.

November 2023: Ups and downs (PDF 1.57MB)
The battle between economic tailwinds and headwinds continues to play out. A turning housing market, surging net migration, and expansionary fiscal policy are landing some hefty blows against contractionary monetary conditions, softer global demand, and heightened geopolitical tensions and global market volatility. There are clear winners and losers in the resulting patchy outlook. Overall business sentiment is well off the floor, but remains generally low. Until the RBNZ has CPI inflation back in the bag, it’s hard to see economic conditions turning ‘rosy’ any time soon. However, whether it’s a stronger housing market, a lower exchange rate (adding fuel to the net exports recovery), or a stronger household sector, it’s still a case of be careful what you wish for. With inflation this high, monetary policy would have to lean against any sources of renewed (or sustained) inflation pressures with a higher OCR than otherwise, whether that’s a higher peak than the current level of 5.5% or a deferral of eventual OCR cuts. In that context, muddling along and quietly disinflating isn’t a bad adjustment path, if the economy can hold the line. Let’s dig into some key drivers in a little more detail. 

August 2023: Waiting on the last domino (PDF 1.64MB)
Drivers of economic momentum are traveling in all directions at present. Fiscal policy will be expansionary in the near term. Monetary policy will not. Net migration is very strong, but easing quickly. Geopolitical tensions remain heightened. Changes to the RBNZ’s macroprudential settings and consumer credit legislation represent a loosening in financial conditions, all else equal. The housing market is now picking up. Falling export prices (particularly dairy) are weighing. High CPI inflation is eroding household incomes, but wage growth is higher, reflecting the tight (but loosening) labour market. Consumer and business surveys have improved, but are still generally low.
All up, it’s hardly surprising that there’s a range of views out there about where things are going. The economy is clearly softening, but is it softening fast enough to prevent high domestic inflation from becoming entrenched? Our expectation: not quite, which is why we expect the RBNZ to return to the hiking table come November.

May 2023: Moving parts (PDF 2.05MB)
The economy is set to slow as 2023 goes on, with our core macroeconomic outlook little changed from our February edition. We expect the lagged effects of monetary policy to become hard to miss as the months go by, with a stagnant housing market, weakening labour demand, slower household spending, and reduced business and residential investment seeing the economy slip into recession in the second half of the year. Given this narrative is well understood and “textbook”, we skip relatively quickly over our central forecasts before getting to the interesting bit – why we might be wrong! There are significant risks on both the upside and downside when it comes to the outlook for both growth and inflation – and of course, by association, the Official Cash Rate. On balance, we see the risks skewed towards the RBNZ sooner or later deciding more is needed to get inflation down, but downside risks have certainly not gone away – and indeed arguably grow in that scenario. More positively, ongoing supply-side recovery is good for both growth and bringing inflation down, and could be a stronger force than our forecasts build in.

February 2023: Brake point (PDF 1.82MB)
A policy-induced recession is looming. While it’s going to hurt some households more than others, we’re hopeful this slowdown will turn the tide on domestic inflation, and set the broader economy on a more sustainable path over the longer run. Risks remain bi-directional, but we think they are broadly balanced around our recently updated OCR call for a peak of 5.25%. But no doubt 2023 has a few surprises waiting for us. This time last year we were forecasting a peak OCR of 3% – and as we go to print the OCR is at 4.25%! We present two ‘plausible’ scenarios that could see the OCR a year from now higher or lower than our forecast by a similar magnitude. Special topics on how the Auckland floods and what tentatively look like strong net migration inflows have been factored into our outlook are on page 9 and 10 respectively.

November 2022: Coming in to land (PDF 1.85MB)
Economic growth is poised to slow as monetary tightening weighs on domestic demand. But the return of international tourism and weaker demand for imports should provide a decent offset in GDP terms. Whether or not New Zealand avoids recession remains a line ball call. But it’s important to note that not all recessions are created equal. A recession that brings about a transition from the currently over-stretched economy towards sustainable expansion, while also avoiding a significant household income shock, may not be as bad as the R-word sounds, particularly from a long-run economic stability perspective. And if it means squashing the current wage-price spiral before it necessitates even more aggressive action by the RBNZ, then it may be a cost worth paying. One way or another, the economy needs to find its way to a sustainable path. Price (and economic) stability is at stake, and so too is very hard-won central bank credibility. Hopefully a 5% OCR is enough to get the job done.

August 2022: On the edge (PDF 1.37MB)
Our forecasts have the NZ economy avoiding recession, but that’s only because we’ve pencilled in a strong recovery in net exports (as over-stimulated demand for imported goods wanes and exports of services recover). But from a domestic (gross national expenditure) perspective, we do expect a contraction over the first half of 2023. If international tourism and education don’t pick up as quickly as we’re hoping, the whole economy could easily slip into recession. But for the RBNZ, given the low likelihood of a sharp supply-side recovery (we’ve downgraded our outlook for net migration), and very strong wage growth, the task of taming inflation hasn’t got any easier. We may have downgraded our outlook for activity, but a decent slowdown will be needed to bring inflation under control. Hopefully, it will take an OCR of only 4% to achieve it. But 7% wage growth certainly takes the edge off the tightening delivered so far.

May 2022: Rebalancing act (PDF 1.85MB)
The economy is transitioning from domestic demand that was overstimulated (with the benefit of hindsight), to a rapid withdrawal of monetary stimulus in order to tame the inflation beast. The reopening of our border will hopefully offset some of the slowing in domestic demand, but it’ll be only a partial offset. It’s a fine balance for the RBNZ as they weigh up the risk of oversteering (engineering a hard landing for economic activity and inflation) against the risk that inflation pressures continue to spiral. At some point in the not-too-distant future, the OCR will be back at a level where these risks are a little more balanced, and decisions will be more difficult.

February 2022: Turning points (PDF 1.69MB)
We're now about two years into the pandemic. While the economic implications are now better understood, and the worst of the data volatility is behind us (touch wood), there is still plenty of scope for surprises. Our focus has shifted from trying to gauge lockdown impacts, and the likely degree of economic scarring associated with them, to trying to gauge the likely evolution of the many drivers that influence both the supply and demand sides of the economy. This isn't anything new when it comes to the art of economic forecasting, but the abnormally long list of turning points for key drivers of economic activity certainly adds to the challenge.