Optimism a recovery is underway

Our GDP growth forecasts don’t show it at first glance, but there’s reason for more optimism about the economy’s prospects in 2025. Revisions to historical data in late 2024 have left the GDP figures with a chunk of negative momentum in late 2024, but other partial indicators have suggested the economy was stabilising or starting to pick up in the latter part of last year. Positive signs for the economy include the following.

• The value of monthly core retail electronic card spending has climbed 3.8% between July and December 2024, following a 4.5% decline over the previous 15 months (seasonally adjusted). The beginning of the pick-up was before the Reserve Bank’s interest rate cuts would have affected household budgets, and it could instead reflect the income tax cuts that occurred at the end of July last year.
• House sales volumes pushed up to a three-year high in late 2024, as interest rate cuts drew more buyers back into the market. House prices have yet to stabilise, but they are likely to start pushing up this year as the stock of properties for sale declines. Residential consent volumes also stabilised in the second half of 2024.
• Business confidence surged more than 40 points higher between June and September (seasonally adjusted), according to ANZ’s Business Outlook. Our own feedback from businesses also suggests that demand conditions in the latter part of 2024 were stabilising or starting to improve.
• Commodity prices finished 2024 significantly higher than they were at the end of 2023, including rises of 35% for meat and 29% for dairy products in New Zealand dollar terms. Horticulture prices also remain at high levels.

On the back of these more promising signs, we expect GDP growth to average 0.5% per quarter this year, which would be a marked improvement on the 0.0% quarterly average throughout 2023 and 2024. Although Graph 1 shows that year-end GDP growth will be negative in the near-term and just 1.0%pa by the end of 2025 due to last year’s recession, the positive momentum gained throughout this year is expected to see year-end growth reach 2.5% by mid-2026.

Graph 1

Monthly employment figures have been weak throughout the second half of 2024, with filled job numbers in November down 1.2% from a year earlier. Last year’s declines are the largest since early 2010. The highly publicised public sector job cuts are starting to show through in the data, although the 0.2%pa fall in public administration and safety job numbers remains relatively modest. Weakness in private sector employment continues to be the main driver of the decline.

A lower participation rate limited the rise in the unemployment rate in the September 2024 quarter. However, we remain of the view that the weakness in job numbers will continue to drive unemployment higher through until the middle of this year, with the unemployment rate forecast to peak at 5.3% in June 2025 (see Graph 2).

Graph 2

On a more positive note, job ad numbers have stabilised since August last year, albeit down more than 55% from their 2021 peak. With employment intentions also tracking higher in the second half of 2024, in line with other aspects of business sentiment, we see scope for a slightly faster reduction in the unemployment rate over the following two years. We expect unemployment to be back down to 5.0% by the end of 2025 and under 4.5% at the end of 2026.

We have outlined above the emerging pick-up in household spending that is underway. In the near-term, we expect the soft labour market to continue to constrain the recovery in household spending, and this view is backed up by Westpac’s measure of employment confidence remaining near record low levels. Additionally, although consumer confidence improved during the second half of 2024, its lift was nowhere near as large as the one in business confidence. Consumer confidence is still in net negative territory and well below its long-term average.

Counterbalancing the effects of labour market weakness on spending are the interest rate cuts that are already having a positive effect on household budgets. The effective mortgage rate, representing the average rate across all fixed and floating mortgages, look to have peaked in October last year, and we estimate that it has eased from 6.4% to 6.2% by January. That drop to date is enough to free up about $8m/week in household budgets for additional spending, representing about 0.2% of private consumption. Further falls in the effective rate to 5.6% by the end of this year would boost those figures to $45m/week and 1.0% of private consumption respectively. Graph 3 shows that overall growth in household spending is set to recover throughout 2025, but with the pick-up not gaining real momentum until mid-year, we do not expect spending growth to get above 2%pa until early 2026.

Graph 3

Against this backdrop, we expect the Reserve Bank to cut the official cash rate (OCR) by 50 basis points, to 3.75%, at its next review in February. As Graph 4 shows, two further 25-point cuts would take the OCR to 3.25% by mid-2025. At this stage, with the OCR close to neutral or just below it, we predict that the Reserve Bank’s work will be done, and it will be happy to let the lagged effects of easing monetary conditions flow through the economy and boost growth throughout the remainder of 2025 and 2026.

Graph 4

However, rapidly evolving international factors could further limit the speed and extent of interest rate cuts during the first half of this year. A substantial fall in the New Zealand dollar, down more than 10% against the US dollar since the end of September, is effectively easing monetary conditions anyway, potentially reducing the number of further interest rate cuts the Reserve Bank needs to do. The lower exchange rate will also lift the price of imported products in NZ-dollar terms, as well as pushing up prices for other tradable products we export such as milk and meat. Higher fuel prices could also lead to another wave of cost-push inflation across the economy.

These inflationary pressures caused by the lower exchange rate come at the same time as financial markets are more worried about demand conditions and some persistence of higher inflation in the US. Expectations of further interest rate cuts in the US have been scaled back recently, contributing to the strength of the greenback.

This combination of stronger global inflation and the weaker New Zealand dollar are likely to push up tradable prices this year. The Reserve Bank’s November Monetary Policy Statement showed a turnaround in tradable inflation from -1.6%pa in September last year to 1.1%pa by the end of 2025, contributing to a temporary upwards blip in headline inflation in the second half of this year. The Bank will be keeping a close eye on international developments as it considers the emerging upside risks to inflation this year and whether a more cautious approach to cutting interest rates is warranted.

One potential source of spending that remains under considerable pressure is the government sector. Revisions to historical data mean it is difficult to make comparisons with prior forecasts, but with government consumption and investment spending at higher levels than previously understood, we have reduced our near-term expectations of growth across both indicators (see Graph 5).

Graph 5

The government’s limited operating spending allowances, which were confirmed in December’s Half Year Economic and Fiscal Update, imply zero real growth in spending going forward. With public sector job cuts only now starting to show through in employment data, we expect government consumption spending to show similar weakness in coming quarters.

However, we continue to harbour doubts about the government’s ability to maintain such a tight fiscal approach ahead of the election in late 2026. We expect growth in consumption spending to pop back up to 1.9%pa by the middle of next year, which is not a particularly rapid increase, but one that demonstrates the difficulties of keeping fiscal policy tight in the face of a middling economic performance and an uneasy electorate.

A massive 15% upward revision in Stats NZ’s figures for historical government investment means more activity is occurring than had previously been estimated, but it also raises questions about the scope for further growth. We now expect a 1.7% contraction in government investment spending this year, but we continue to expect a pick-up again during 2026, as the combination of the government’s fast-track legislation and a desire to deliver on its promise to get things done leads to more activity next year.

The government’s fiscal constraints mean the risks to government consumption spending during 2026 are probably on the downside; the government will be conscious that the more it fails to maintain a tight fiscal approach, the more likely it is to embed structural deficits in the government accounts for even longer than is currently forecast. In contrast, we see upside risks to government investment spending next year if the government is successful in getting new funding mechanisms in place for infrastructure, and the industry has the capacity to deliver on an expanded work programme.

We have discussed several aspects of Donald Trump’s re-election as US president in From the beach 2025, particularly with respect to the global geopolitical situation. In this section we focus on American trade policy and how it might affect New Zealand over the next few years.

The imposition of a blanket 10% tariff on all imports would undermine the growth in New Zealand’s exports to the US that has been achieved over the last five years. To be clear, New Zealand would not be at a disadvantage relative to any other countries exporting to the US, who would presumably face the same tariffs. But the tariff wedge in the US between imported and domestic products would presumably see American consumer demand moving back towards the latter. That means lower export volumes, and probably lower prices, for New Zealand beef, wine, and dairy products.

The threat of much larger US tariffs being imposed on China also threatens New Zealand’s export incomes, particularly given the ongoing malaise affecting the Chinese economy. Reduced US demand for Chinese products would compound weak production activity in China, adding to the other problems undermining economic growth such as the shrinking population, high youth unemployment, and housing oversupply. Expectations of weak economic growth in China could weigh on New Zealand’s export prices over the medium term.

However, the news is not all bleak. Firstly, we have already seen the shift of some production out of China to other southeast Asian countries in recent quarters in response to President Biden’s tariffs on products such as semiconductors or electric vehicles. This shift has boosted economic activity in countries such as Vietnam, Japan, and South Korea, opening other opportunities for New Zealand to pursue export growth instead.

Secondly, the spare capacity and excess production occurring in China could mitigate some of the other international cost pressures we noted earlier. Cheap Chinese production made the country an effective exporter of disinflation throughout the 2010s, and we could see a similar phenomenon reappearing over the next couple of years.

To reduce our dependence on China, New Zealand has also been pursuing free-trade agreements with several other countries over the last few years. Free-trade agreements that have been reached (noting that not all are yet in force) within the last two years include with the UK, the EU, the UAE, the Gulf Cooperation Council, and selected products with Costa Rica, Iceland, and Switzerland. India, now the world’s most populous country, remains a key target as well. This broadening of New Zealand’s trade networks demonstrates an official political understanding of the benefits from trade and the need to diversify our export markets rather than having an overreliance on China.

Nevertheless, uncertainty around the global geopolitical situation is more heightened than it has been for several decades. Increasing tension between the major international powers has the potential to significantly alter the medium-term outlook for the globe, from both an economic and diplomatic perspective.

There’s reason for optimism about the New Zealand economy and business conditions over the next 24 months, as the post-pandemic recession gets put behind us and interest rates return to more normal levels. Better growth outcomes will be underpinned by increased household spending, a more stable housing market, and strength in export commodity prices, although economic growth is not forecast to get above 2.5%pa. The story of stronger export incomes also needs to be viewed in the context of heightened uncertainty about the global geopolitical and trade environment. One area where the legacy of COVID will continue to be felt for several more years is in terms of fiscal outcomes, even if the coalition government embarks on a bit of pre-election spending in 2026.