Economic insights with Cameron Bagrie

The perfect storm brewing for New Zealand's economy

There is an old saying that history doesn’t repeat but it often rhymes.

We all saw the inflationary consequences of Covid. It was ruthless, and the RBNZ drove the economy into recession to break the back of inflation. Costs are hard to pass on when demand disappears. It was a reminder of why we brought in an inflation targeting regime and an independent central bank. Inflation siphons money out of people’s pockets.

Now another inflationary cocktail is in the making with another series of supply shocks to consider. The focus is on oil/gas/fertiliser/Hormuz – which represents both an energy and food shock. 

We had the first oil shock in 1973 courtesy of the Yom Kippur war. Then a second in 1979 courtesy of the Iranian revolution. Six years were in between. It is now six years after Covid, and the first inflationary hit. Hence, charts are doing the rounds comparing the two periods. 

Central banks are providing soothing nuances so far but should be wary. Chicken Little can stay in the coop, but neither should we shy away from reality.

Hormuz is the initial choke-point but attention is quickly turning to Asia given its dependence on Hormuz. And Asia’s problem is our problem because we get our fuel from Asia. 

The playbook

The Reserve Bank’s Governor has shown us their playbook. They will not respond to the direct (fuel) or indirect effects (transport costs) of this price shock. That is central banking 101. 

We’ve seen four instances in the past twenty years when fuel prices rose 30%, and they went down soon after.  So central banks look through such shocks. They can’t control petrol prices.

An energy price shock also forces consumers to alter spending patterns. As people pay more for fuel, they spend less on other items, which is disinflationary.

The challenges

Beyond the obvious issue of uncertainty over the length of the current spat, with everyone hoping the duration does not extend too long, central banks need to be alert.

Early in the conflict the Treasury came out and said inflation of 3.7% was their worst-case scenario. Now that’s looking like the best case! My concern is broader when it comes to inflation. These concerns can be broadly grouped into five areas:

1. This is more than one shock

The world is not just dealing with an oil price issue - we are also dealing with Trump’s tariffs, the battle for rare earths and maritime logistics becoming geo-strategic and geo-political. Government military spending around the globe will go “ballistic” meaning we can expect little fiscal retrenchment and more debt. Lord forbid if China decided now is the time to have a crack at Taiwan.

2. Unfavourable starting positions 

You are better able to absorb a shock if you have a favourable starting position, but many central banks never got completely on top of the previous bout of inflation. US core inflation has been running around 3% and is rising. The Reserve Bank of Australia has already hiked rates twice this year due to core inflation sitting around 3-3.5% with the headline rate of 3.7%.

If there is some solace to take out of this shock it is that New Zealand is likely to out-perform Australia over the coming two years.

New Zealand managed to get core inflation down to 2.5%.  That’s close to RBNZ’s 2% target2, but not 2% - and it ticked up in the December quarter of 2025.

3. A potential inflationary bow-wave 

ANZ’s latest Business Outlook Survey for March shows a net 60% of firms are intending to raise prices. This series averaged +21 from 1992 to 2019 when inflation averaged 2%. +60 is almost three times the historical average.

This shows that there is pent up pressure to pass on price increases and recover lost margins. Cost shocks provide an excuse to lift prices, especially when you lack a lot of competition, which is a problem in NZ and Australia.

These potential price rises represent a second-round inflationary effect which any central bank would be concerned about.

Further sign we should expect second round inflation is inflation expectations – the level of inflation people and professional forecasters expect to see down the track. Inflation expectations, often seen as a measure of a central bank’s credibility, have been drifting up. They are not bad but are far from ideal. 

4. A lack of productivity growth

Productivity underpins living standards over time but also helps absorb pricing challenges.

New Zealand used to record annual growth in productivity of 1.4% per year.  This decade our average is now 0.3%. 

The farming sector is still getting productivity growth of around 2%, at the frontier of where New Zealand needs to be.

The Reserve Bank’s Chief Economist hit the nail on the head recently. He repositioned the cost-of-living crisis as an income crisis, which in turn is a function of productivity. Lacking productivity, wages stagnate, and cost of living pressures hurt even more. 

5. Populism

Political leadership in many key nations is becoming increasingly populist. This growth in the political periphery drives extremism and some crazy policy. The USA, UK and Australia are seeing it. We reside in a world where self-interest trumps group interest.

The bottom line

The inflationary shock we are experiencing is one thing but the broader parameters around it take it to a new level of risk.

I hope the RBNZ Governor’s playbook plays out, and they can look through this inflation shock. I’m not inclined to bet that way though.