State of the Nation, August 2025

The New Zealand economy is gradually recovering from the inevitable painful slowdown that followed the unsustainable boom in housing and domestic demand brought about by too much monetary and fiscal stimulus in response to the Covid-19 pandemic. 

The recession was deliberately precipitated by the Reserve Bank (RBNZ) in response to CPI inflation shooting higher, but some degree of payback was always going to occur. The good news is that the RBNZ has decided the economy has had enough pain to head off inflation and has been steadily cutting the Official Cash Rate, which is now at 3.25%, 200bp lower than its peak.

How much further interest rates may fall is a question that is exercising both financial markets and homeowners. The RBNZ has slowed down its cuts, deciding that the recent lift in headline inflation and some measures of inflation expectations warrant a second look. Fair enough, but our view is that these concerns will dissipate fairly rapidly, paving the way for more cuts than currently expected. Indeed, we are forecasting a 25bp cut not only in August, but also in November and a final cut in February, though we are describing that one as “pencilled in” and contingent on how global factors affect the domestic economy.

Our view is predicated on the fact that the domestic recovery has been very stop-start. Retail, services, manufacturing, hospitality, construction, and the housing market are all experiencing a longer period of softer activity than was expected at the start of the year. Firms are certainly reporting that cost pressures remain, but their ability to pass those costs on is severely constrained by very price-sensitive consumers across the board.

There is one marked outlier: the agriculture sector. Commodity prices have held up remarkably well, with the dairy and red meat sectors particularly buoyant. Global dairy prices are now trending lower, so there’s no guarantee the buoyant mood will stick around indefinitely, but a high payout has boosted rural regions – not just farmers, but support industries and broader spending in the regions. We are expecting a supply response in both the dairy and red meat industries that will see something of a rebalancing, and global growth is set to be challenged by evolving US tariff policy. But for now, the agriculture sector is a real standout in an otherwise stuttering economic performance.

Recent data has been rolling over, particularly business survey data. Our own Business Outlook survey, the NZIER’s Quarterly Survey of Business Opinion and the Performance of Manufacturing and Services indexes have been united in indicating that economic momentum has stuttered in the second quarter of the year, suggesting a meaningful risk that GDP growth could even be negative in the quarter.

Monthly jobs data is suggesting that employment could also have declined in the quarter. 

The housing market has been going nowhere to backwards for months – we are now forecasting just 2.5% price growth this year, less than the RBNZ, and the most recent REINZ data suggests downside risk to that forecast, with both house sales and prices falling in June (seasonally adjusted).

It always takes a surprisingly long time for the impact of monetary policy to feed through, and every week more people are rolling over onto lower mortgage rates. However, the economy could clearly do with a shot in the arm via lower interest rates.

The RBNZ would agree, objectively, but their ability to support growth does depend completely on the outlook for inflation. And on that front, it’s not surprising to see a range of views. 

Headline inflation has bounced back up to 2.7%, uncomfortably close to the top of the RBNZ’s 1-3% target band, with particular stickiness in prices the RBNZ can’t do a great deal about, like rates, electricity, dairy, meat, fruit and vegetables. 

Core measures are generally more benign. The RBNZ’s ability to ‘look through’ inflation that isn’t related to the strength or otherwise of the economy depends on whether they think there is a meaningful risk it could spill over into more persistent inflation, by affecting inflation expectations. One member of the RBNZ Monetary Policy Committee was sufficiently concerned about that risk to vote against cutting the OCR in May. 

However, our view is that those concerns will soon be ameliorated as the weakness we are seeing in real activity gradually brings the Committee around to the view that the more pertinent risk is that inflation will drift too low over the medium term.

Global risks are difficult to gauge accurately. At the time of writing, New Zealand is in the favoured minimum tariff camp with a 10% tariff. Given the US only takes around 12% of our goods exports, the direct impact is very manageable. The more concerning potential impacts are on our commodity prices (particularly if China’s economy slows markedly) and on confidence to invest and employ.   

On the first front, it’s a case of “so far, so good”. On the latter score, it’s entirely possible that the tariff noise and uncertainty since April has contributed to the loss of momentum in the economy in recent months. 

We ask firms in our Business Outlook survey about what is driving their investment decisions – the global economic outlook has jumped into second place amongst firms who are planning on reducing their investment. It’s a headwind for our economic recovery, one which monetary policy can offset by easing policy a little more.

Ultimately, interest rates will be whatever they need to be to ensure the economy keeps moving forward, assuming we are right in our assessment that inflation is indeed tamed. “Survive to ‘25” may have given way to a simple “Survive ‘25”, but better times do lie ahead.