The chaos of Trump and his tariffs

The New Zealand economy is – or at least was – in the early stages of recovery from its post-COVID hangover. GDP expanded 0.7% in the December 2024 quarter, although the positivity of that figure needs to be tempered by the size of the economy’s contraction during the recession of the previous two quarters, by 2.1%. The economy is still 1.5% smaller than it was in March last year, and on a per-capita basis, activity is down 4.4% from its September 2022 peak.

Strong business confidence throughout the second half of last year has been joined by a gradual recovery in consumer spending, emerging expansion in the manufacturing industry for the first time in two years, and more stable job ads and filled job numbers. Business investment, outside of construction activity, has also shown signs of turning around. The effects of lower interest rates and higher agricultural incomes looked set to stimulate further growth in spending activity across the economy as 2025 progresses.

But these positive domestic indicators have been overshadowed by unfolding turmoil internationally. It has been less than three months since President Trump’s inauguration, but he has been in fast-forward mode advancing a policy platform that includes slashing US public sector jobs and spending, introducing a wide range of protectionary tariffs on imports to the US, and upending American foreign policy norms of the last seven decades.

Financial markets have expressed their opinion about the developing global trade war, and it hasn’t been positive. President Trump’s tariffs are expected to result in recession in the US, knocking as much as 1.1 percentage points off GDP growth this year as economic activity is constrained by higher prices and reduced supply. Weaker US demand will have flow-on effects for economic growth around the rest of the world, although the magnitude of the hit will be less pronounced elsewhere given that the increase in barriers is only on trade with the US, rather than all exports and imports. Even so, the escalation of tit-for-tat tariffs between the US and China is particularly concerning given the importance of China to the global economy, its pre-existing domestic economic struggles, and its position as New Zealand’s largest export market.

Prior to the announcement on “Liberation Day” of widespread tariffs, we explored some of the implications of the emerging trade war on New Zealand. Wine and beef exports are likely to come under pressure from the 10% import tariffs being levied on New Zealand products. Wine producers have already suggested cutting prices to maintain their competitiveness in the US market, but beef export revenue might be less affected given the currently constrained domestic beef supply in the US.

Beyond these direct effects, weaker global growth could spell more difficult conditions for our exporters more broadly. Since the end of 2023, ANZ’s Commodity Price Index shows a 29% lift in global prices for our meat exports, 25% for dairy products, and 7.7% for horticultural products (see Chart 1). The lower exchange rate has boosted NZ-dollar prices by another 8-14%, setting the platform for a strong recovery in provincial and rural economies this year. However, questions must now be asked about how long those higher prices might last.

Chart 1

Source: ANZ

Chart 2 shows that we have revised down our forecasts for export growth between mid-2025 and mid-2027 due to the fall-out from the trade war. We forecast just 0.4% growth in export volumes during 2026 as the gears in the global growth machine seize up. Export growth is expected to pick up in 2027/28 as new trading patterns and relationships emerge, and businesses and other nations adjust to become less reliant on demand from the US.

Chart 2

Source: Stats NZ, Infometrics

The hit to export incomes will have flow-on effects for other parts of the New Zealand economy. We expect the recovery in business investment that started to emerge in late 2024 will become stunted as this year progresses. Businesses’ ability to commit to major investment decisions will be reduced by prospects of softer revenue, and their willingness to spend will also be undermined by the volatility and uncertainty of the global economic environment. Chart 3 shows more limited growth in business investment during 2026/27, and we have also revised down our forecast growth in household spending over the next couple of years.

Chart 3

Source: Stats NZ, Infometrics

Import tariffs in the US are also expected to result in higher US inflation during 2025, estimated to be as much as 2.9 percentage points by The Budget Lab . This mix of slower economic growth and higher inflation places the US Federal Reserve in a difficult position as it tries to weigh up the conflicting policy response demands. For now, Chair Jerome Powell has stated that the Fed will take a wait-and-see approach. However, financial markets are betting heavily on the likelihood that the effects of weaker economic growth will win out, and they are picking 4-5 interest rate cuts to occur in the US before the end of this year.

From a New Zealand perspective, the inflation implications are more ambiguous. For the 10% of our imports that come from the US, prices are likely to be higher due to increased input costs faced by American producers. Where other countries have introduced retaliatory tariffs on the US, there is likely to be a smaller flow-on effect into input costs and, ultimately, New Zealand import prices as well. Higher costs from upheaval and adjustment to global supply chains are also likely to add more pricing pressure into the mix.

At the same time, the prospect of slowing global growth means that international demand conditions will be softer – an outcome that would generally be expected to lead to lower prices and discounting as producers struggle with spare production capacity and excess inventory levels. With US tariffs of over 100% announced on imports from China, producers in the latter country are likely to be looking for places to offload stock and grow their market. New Zealand consumers could benefit from a greater availability of cheaper imports, at least in the short term. Lower oil prices due to the softer global outlook also shape as a potential downside risk to our inflation forecasts.

Weaker domestic demand conditions are also likely to reduce the scope for businesses to push through price rises within New Zealand. The 2024 recession saw businesses move away from the cost-plus mentality that had become prevalent during the pandemic, and become much more reluctant to put up prices, for fear of losing market share. There had been some concern that this year’s economic recovery, combined with lingering pockets of price pressure, could see the cost-plus approach re-emerge later in 2025. However, a more stunted economic recovery means that businesses are likely to remain wary of lifting their prices.

Taken all together, we have revised up our inflation forecasts during 2025 and 2026. This change has resulted partly from the tariffs, and partly from a bit more pricing pressure emerging early this year. Contributors to the latter include elevated worries about US inflation prior to the tariffs, continued weakness in the New Zealand dollar, and specific areas of rising prices such as electricity costs. Chart 4 shows that we now expect inflation to peak at 2.8%pa in the second half of this year and hold at or above 2.4%pa through until early 2027.

Chart 4

Source: Stats NZ, Infometrics

Although we forecast inflation will remain significantly below the 7.3%pa rate reached in 2022, the uptick during this year might leave the Reserve Bank a little uncomfortable. The Bank will be aware that it can do little about the immediate supply-side inflationary effects of the trade war, but it also needs to ensure that second-round effects do not escalate – and that inflation expectations remain well anchored.

Against this backdrop, we expect the official cash rate (OCR) to be lowered from 3.5% currently to 3% by July this year (see Chart 5). With a 3% OCR estimated to be neutral, the risks to this interest rate forecast lie to the downside, if inflation remains more subdued than expected or the Reserve Bank believes the economy needs more support. It is worthwhile reiterating, however, that controlling inflation is the Bank’s primary mandate, and that slow economic growth on its own is not a justification for cutting interest rates.

Chart 5

Source: RBNZ, Infometrics

One of the interesting aspects of stronger economic data in the second half of 2024 was the promising recovery in retail spending. Given last July’s income tax cuts and the downward trend in mortgage rates, the data suggested that households were responding to the lift in their disposable income by spending more. However, December quarter GDP data showed that most of the growth in spending was instead coming from increased tourist numbers.

This variance, and the lack of momentum in household spending to date, has been a contributing factor to our slower forecast recovery in private consumption this year, alongside the negative effects noted earlier of the trade war on confidence and export incomes. It also has important implications for the distribution of retail spending, with growth in hospitality and arts and recreation outpacing many other parts of the retail sector. The effects of the tourism recovery are also apparent at a regional level, with Queenstown and some other parts of the South Island particularly benefitting from increased visitor numbers and spending activity.

Slower global growth because of the trade war will drag on the continuing recovery in international visitor numbers, particularly from our key tourism markets of China and North America. Year-end growth in tourist numbers is forecast to hold above 7%pa throughout this year, before easing to just 0.7%pa by September 2026 as people’s willingness to spend on long-haul holidays is squeezed. Arrivals over the year to February 2025 averaged 86% of their 2019 level, but they are now not forecast to surpass their pre-COVID level until 2028. Continuing increases in visitor numbers will help sustain further economic growth in tourism-dependent regions, but not to the same degree as during the last couple of years.

Net migration has weakened substantially since its 2023 peak, easing from 135,530pa in October that year to 32,471pa by January 2025. The rapidness of the fall has seen us repeatedly revise down our migration outlook across recent forecasts.

However, recent trends in the data suggest that foreign arrival numbers might be starting to stabilise, at what would be a historically high level. These figures could still change, with the latest monthly estimates from Stats NZ always having the potential for significant revision. Indeed, a plateauing of foreign arrivals would be somewhat surprising given there is a lack of job opportunities, and the unemployment rate is still rising.

The changing trend has led us to revise up our migration outlook (see Chart 6), with annual net migration of 22,480 by the end of this year about 20,000 higher than we were forecasting in January. Our net migration trough of -1,553 at the end of 2026 is also less negative than the -12,252 we were previously forecasting for the year to March 2027. Higher net migration over the medium-term also has positive implications for housing demand, residential construction activity, and the economy’s potential growth.

Chart 6

Source: Stats NZ, Infometrics

As always, the risks around net migration remain considerable. New Zealand’s weaker growth outlook in the short term could easily lead to a renewed softening in arrival numbers or further increases in the number of Kiwis leaving for Australia. Migration is also highly exposed to the vagaries of government policy decisions. We are conscious that any future period of faster economic growth could see immigration rules relaxed, particularly for lower-income roles where the availability or willingness of New Zealanders to do the work is perceived to be limited. Furthermore, we have seen previous National-led governments be willing to use immigration to generate faster growth when the economy is struggling. Given the prospect that the anticipated economic recovery over the next 18 months will be stunted by fallout from the US trade war, higher immigration might be an easy way of achieving better headline GDP results leading into next year’s election. Watch this space!

As we started the process of preparing these forecasts, there was a sense that the New Zealand economy was evolving largely as we had expected in January. Put another way, without the tariff meltdown of the last few weeks, our forecasts would have been boringly similar to the ones published three months ago. Chart 7 shows how much of a shift in our expectations around economic growth that recent international events have caused.

Chart 7

Source: Stats NZ, Infometrics

US tariffs are a massive spanner in the works – particularly in terms of China, but also recognising that the baseline 10% tariff for all countries still represents a significant increase in trade barriers. The uncertainty around our forecasts is on par with the Global Financial Crisis, but probably not as acute as during the early days of the COVID-19 pandemic. We will continue to monitor international events and update clients as our understanding of the changing trade environment, and the implications for New Zealand, evolves.