It was pleasing to see most equity and bond markets finish the quarter higher, but we remain relatively cautious as we are starting to see the cumulative effect of the interest rate hikes over the past 12 months or so.
Firstly, the failure of two US banks was part due to higher interest rates, and part due to poor risk management in dealing with the move higher in interest rates.
And in New Zealand, borrowers are starting to roll off ultra-low mortgage rates. This is going to slow household spending further, as disposable incomes fall. It appears to have already started, with GDP growth data showing that the local economy contracted in the final quarter of 2022.
Looking ahead, sticky inflation and robust labour markets continue to pose challenges for policymakers to bring inflation back to target levels.
Meanwhile, the biggest risk in the wake of the bank failures is to what extent it will tighten financial conditions. A tightening of conditions will make borrowing more challenging which would likely weigh on growth and potentially be detrimental to labour markets and inflation.
Finally, given the risks discussed, our base case now leans towards a mild recession that is more likely to begin in the second half of this year, rather than early in 2024, as the market had previously expected.