US President Donald Trump’s “Liberation Day” tariffs were announced right in the middle of us finalising our April forecast numbers. For a short time, it looked as though our July forecasts might be subject to the same uncertain fate, with Israel and Iran engaging in a brief conflict that pulled in the US and threatened to draw in other nations. But as has so often been the case throughout a volatile geopolitical year, the initial headlines dissipated, and things settled down to be nowhere near as bad as first feared.
Much of our commentary following our April forecasts was that, even if the US tariffs announced early that month were not fully implemented, the uncertainty created by them would be enough to drag down US economic growth. In turn, these downward revisions would negatively affect broader global growth and stunt New Zealand’s fragile economic recovery.
This prognosis was partly right – Consensus forecasts for US economic growth in 2025 were downgraded from 2.2% to 1.2%pa between February and May. But growth forecasts for other regions around the globe were lowered by no more than 0.2 percentage points over the same period. And by June, expectations of US growth this year were improving again – although some of that lift might be a strong but possibly distorted March quarter result, as businesses front-loaded spending to avoid higher costs after tariffs were introduced.
The immediate risks to the global economy from conflict have also been scaled back. A ceasefire has been reached between Israel and Iran, with pressure for deals in the Israel-Hamas and Ukraine-Russia conflicts as well.
Financial markets are taking it all in their stride – international share markets are back up close to, or at, record highs. Business confidence has also recovered the ground lost in late April and early May and is just below March’s 11-year high. There’s almost a sense that market participants have become desensitised to the persistent uncertainty and “noise” about the economic outlook, and they are largely attempting to get on with life as normal.
This apparent resilience had led us to revise our forecasts for New Zealand’s economy during 2026 back up – not to the growth rates we were forecasting at the start of this year, but considerably more positive than we were predicting in April (see Chart 1). We expect less pressure on exports than initially anticipated under the tariffs, particularly if the final US-China tariffs settle considerably below the 145% that seemed likely in late April. We expect this better export outlook to flow through into a more robust recovery in household spending during 2026 as well.
Chart 1
Source: Stats NZ, Infometrics
It’s important to reiterate that many of the negative factors and associated downside risks to economic growth have not completely disappeared. US import tariffs are set to stay at a minimum of 10% and are likely to be higher for many countries in the wake of the 90-day pause ending. China’s economic outlook remains unconvincing, and a modest softening in Global Dairy Trade prices over the last two months could be an early warning sign of broader export price weakness.
In short, our previous April 2025 forecasts should now be seen as a realistic downside scenario for the New Zealand economy.
How much need, or confidence, is there to invest?
Against this backdrop, the one part of the economy we have been reluctant to revise up our forecasts is private sector investment. Chart 2 shows that our outlook for private investment is more positive over the next 18 months, but year-end growth of 3.9% in June 2026 is well below the peak of 5.9%pa growth at the end of next year that we were predicting in our January forecasts.
Chart 2
Source: Stats NZ, Infometrics
We remain of the view that global uncertainty will be a limiting factor in investment spending during the rest of 2025 and 2026. The emerging recovery in investment during late 2024 and early 2025, and the associated optimism about economic prospects, continues to feel a little premature, given the patchy nature of economic growth to date. And even with investment intentions at their highest level since 2021, the rationale for a rapid lift in investment seems thin given the spare capacity and underutilised resources across the economy at the moment.
However, there is a chance that strong business confidence and high investment intentions help foster the economy’s recovery and essentially become self-fulfilling. The government’s Investment Boost policy, announced in May’s Budget, could also help accelerate the lift in capital investment, with the 20% immediate cost deduction particularly providing tax and cashflow relief for assets that would otherwise depreciate relatively slowly. If broader global economic conditions remain relatively benign, we see upside risks to our private sector investment forecasts.
Speaking of upside risks, the government’s intentions around investment in social and civil infrastructure could also lead to faster economic growth than forecast during 2026. At the moment, there remains a sizable disconnect between the rhetoric around Wellington and the reality of activity on the ground, and Chart 3 shows that we are forecasting a 7.5% contraction in government investment during 2025 – the weakest result since 2012/13. However, a supersized push to get contracts signed and projects underway ahead of the 2026 election threatens to create a tsunami of activity before the end of next year, driving a larger rebound than the 4.9% growth we are forecasting in the March 2027 year.
For the government to be successful in progressing much-needed infrastructure investment, though, it will need to accelerate planning and design processes, as well as overcome possible labour and resourcing shortages in the sector. This haste to deliver could lead to poorly considered investment decisions, as well as creating demand pressures in the industry that would lead to higher costs and lower value-for-money outcomes.
Chart 3
Source: Stats NZ, Infometrics
The recovery is coming, but it’s taking time
Our previous forecasts have highlighted two key contributors to the economy’s expected recovery from last year’s recession: higher export prices leading to increased spending in the provinces, and lower mortgage rates freeing up more cash for consumer spending. However, the recovery to date has been a slow burn. Household spending, for example, looked livelier in the latter part of 2024, but it has failed to sustain that momentum this year. And the flow of cash from higher milk and meat prices, into farmers’ bank accounts, and then through into more provincial economic activity, is taking time to be realised.
Significant amounts of land conversion to dairying during the 2000s saw agricultural debt levels rise from 11% of nationwide GDP in 2001 to 24% of GDP by 2009, and debt was still at 23% of GDP in 2016. Relative to GDP, agriculture debt levels are now at their lowest since 2003, as tougher capital requirements and tighter lending conditions have reduced the availability of finance and pushed up the cost of funding for the sector. Even with these lower debt levels, interest costs faced by farmers during 2023 and 2024 were at their highest since about 2015. Given these costs, and the significant squeeze on profitability during 2022 and 2023 from other significant cost increases, it is unsurprising that farmers are shoring up their financial positions and taking an even more cautious approach than usual when considering spending and investment decisions.
Whereas debt-servicing costs for farmers and businesses peaked in late 2023, the prevalence of fixed mortgages meant that household interest costs didn’t peak until a year later, in October 2024 (see Chart 4). Even by April 2025, mortgage-servicing costs for households were higher than they were at the end of 2023 – when household budgets were under considerable pressure and the economy had already been tracking sideways for a year. We expect the effective mortgage rate to drop another 50-70 basis points by mid-2026, meaning that there is considerably more relief yet to come for households. In other words, people clamouring for further interest rate cuts because of the patchy and sluggish nature of the economy’s recovery need to have more patience for the effects of the rate cuts so far to work their way through the system.
Chart 4
Source: RBNZ, Stats NZ, Infometrics
Another pillar of the recovery is a turnaround in the labour market. Job ad numbers and monthly employment data have been relatively disappointing so far, with job ads tracking sideways since mid-2024, but not showing any signs of improving yet, and with monthly job numbers charting a similar course since about October last year. As with business investment, uncertainty and spare capacity have the potential to dampen or delay the expected pick-up in hiring activity. Surveyed employment intentions are reasonably positive, albeit below the strongest results seen in 1993-95, 2013-17, and 2021.
The lack of improvement in the labour market indicators to date has led us to push back our forecast timing of the peak unemployment rate by one quarter, to the September 2025 quarter. However, we still expect unemployment to dip from 5.3% to 4.5% by the end of 2026, with a further easing to 4.2% by the end of 2027.
More inflation, but how persistent is it?
One of the most debated aspects currently within our forecasts is the outlook for inflation. Inflation accelerated to 2.5%pa in the March quarter, and we expect it to push higher in the second half of this year, with increased pressure coming from electricity, gas, and food prices, as well as continuing increases in government charges. Although our forecast is for inflation to peak at 2.7%pa, there is a reasonable risk that it will spike outside the Reserve Bank’s 1-3%pa target band in the short term.
The big question is what happens to inflation next year. Chart 4 shows that we see less price pressure being sustained into 2026 than in our April forecasts, with tariffs and the international trade war looking likely to be less acute than initially feared. The New Zealand dollar has also recovered from its early-2025 lows, particularly against the US and Australian dollars, which will reduce pressure on imported product prices. As a result, we expect inflation to be back down to 2.1%pa by mid-2026.
Chart 5
Source: Stats NZ, Infometrics
Perhaps the biggest difference between now and four years ago is that broader inflation expectations have remained well contained this time (so far). The pockets of larger price rises are more isolated cases than the broad rush of inflationary pressures seen in 2021/22. The NZIER’s Quarterly Survey of Business Opinion also offered good signs on the inflation front, with net responses for average prices over the last three months and expected average prices over the next three months both turning negative for just the third time in the last 26 years. With Survey responses offering a good indicator of inflation in 2-3 quarters’ time, we are hopeful that inflation moderates again during 2026.
Nevertheless, there is a lingering air of concern about this year’s acceleration in inflation amid sluggish demand conditions and considerable spare capacity across the economy. It was little more than a year ago that inflation was outside the Reserve Bank’s target band, with the Bank’s erroneous assumption that price pressures were temporary having let inflation run away to a 32-year high of 7.3%pa. Having worked to regain its inflation-fighting credibility over the last three years, the Bank will be wary of making the same mistake again.
Inflationary pressures are the area we, and the Reserve Bank, are looking at most closely. The uncertainty around the inflation outlook and the lags in the economy between growth, the labour market, and pricing behaviour, are substantial.
These concerns mean the Reserve Bank has limited scope to cut interest rates further for now, and we expect the official cash rate (OCR) to bottom out at 3%. Some other forecasters are predicting cuts to take the OCR down to 2.5%. However, we think that by the time the near-term inflation risks have subsided, New Zealand’s economy will have gathered sufficient momentum to make further stimulus unwarranted.
Our forecasts beyond 2025 see the OCR holding at 3% for an extended period. At the moment, we see nothing in the medium-term outlook to necessitate a shift in monetary policy away from interest rates that are roughly neutral. Of course, shocks are likely to emerge over time and, if anything, we see the risks to this interest rate forecast as slightly on the upside.
A slow grind back to better times
Our economic outlook is more positive than in April, but with forecast GDP growth averaging 2.1%pa over the five years to June 2030, it’s still not a stellar outlook. Businesses that have been doing it tough since per-capita GDP peaked at the end of 2022 have understandably been holding out for a recovery. Lower interest rates are an important contributor to an improving outlook, but the effects are taking time to flow through into household budgets and spending. Tight fiscal policy and weaker net migration are factors that mean some other parts of the economy are weighing on the recovery, while global uncertainty remains potentially problematic for the export sector.
As it stands, we don’t expect per-capita GDP to surpass its 2022 peak until the second half of 2027. To put it in perspective, that gap of almost five years until the previous peak is surpassed is the same length as the gap following the Global Financial Crisis. The reality is that the economy was extremely overheated during 2022, so a quick return to those sorts of activity levels can’t be expected. And with New Zealand’s productivity performance remaining problematic, we are sceptical about the economy’s ability to achieve faster growth going forward.
