Rising interest rates lead to economic caution

NZIER forecasts weak growth as households cut spending

Rising interest rates lead to economic caution

Households and businesses in New Zealand are exhibiting increased caution due to rising interest rates and uncertainties surrounding the new government’s priorities on spending and public sector cutbacks, according to the latest quarterly predictions from the New Zealand Institute of Economic Research (NZIER).

This caution has reversed the post-election confidence rebound observed at the end of 2023, with soft demand now a key characteristic of the economy, contrasting with the severe supply constraints experienced during the COVID-19 pandemic.

Despite a strong increase in population driven by migration, NZIER forecasts weak annual average economic growth of about 1% for the coming year. Economic activity on a per capita basis is declining as households and businesses reduce spending and investment in light of ongoing challenges.

Many households have notably cut back on discretionary spending due to significantly higher mortgage repayments as they transition from historically low fixed-term mortgage rates. This trend is expected to persist, leading to further economic slowdown over the next year as more households adjust to higher mortgage rates.

Inflation in New Zealand is easing, but some domestic inflation pressures remain. Non-tradable inflation continues to be high, indicating capacity pressures in certain sectors of the economy. Housing-related costs, such as rents and service prices, are rising faster than overall inflation.

NZIER maintains its forecast of an official cash rate (OCR) cut from mid-2025. The Reserve Bank of New Zealand (RBNZ) recently signaled a later start to the monetary policy easing cycle and did not rule out a potential OCR increase due to persistent high non-tradable inflation. However, NZIER does not expect the RBNZ to raise the OCR in the current cycle, citing earlier communications from the central bank that set a high threshold for such a move.

NZIER predicts the RBNZ will exercise caution in starting its easing cycle and will likely cut the OCR from mid-2025 once inflation is sufficiently controlled to remain around the 2% target. This approach is seen as prudent given the deteriorating growth outlook and the risks to inflation.