Economic insights with Cameron Bagrie

Good news can bring bad news

In my last update, I noted that “the economy has turned the corner in a more substantive manner of late. The conviction is growing, there are better times ahead in 2026.”

The good news

A ripper third quarter growth figure of 1.1%  (real or inflation-adjusted growth) represented a material bounce-back from a sharp contraction in the second quarter. That third quarter data is now dated, but the Reserve Bank’s Nowcast estimate (which combines timely partial indicators) for growth in the fourth quarter of 2025 stands at 0.5 percent, and 0.7% for the first quarter of 2026.

The economy is moving forward.

However, with the level of activity well below where we were in 2023, the economy is still climbing out of a hole. GDP per capita (population-adjusted growth) is 3.3% below the peak.

Various leading indicators, such as ANZ’s Business Outlook Survey, NZIER’s Quarterly Survey of Business Opinion, or concurrent measures, such as the Truckometer (which tracks traffic usage), are telling a similar story. We have forward propulsion.

However, some sectors continue to lag. The housing market, which is typically very responsive to low interest rates (and helps drive a cyclical recovery) has failed to fire. Two major banks have downgraded their expectations for house price growth to 2% in 2026. The Treasury’s expectation of 6–7% house price growth is looking like pie-in-the-sky stuff.

Housing supply (proxied by building consents, which are 36,000) is exceeding demand (proxied by population growth of 33,000 divided by 2.5 people per house).

Regional momentum: Rural strength leads the recovery

Auckland’s got the highest unemployment rate in the country, and in the deep south, there’s the lowest. That’s telling about where we’re seeing growth and where the momentum driving this economic recovery is coming from.

The mood is actually pretty positive - people have money in their pockets, and while they’re not splashing the cash around, they’re spending a bit. Tractor sales and registrations dropped 13% on a year ago, which is a double-digit number, not a single digit, and that’s just another barometer showing more momentum and strength coming through. The rural community is driving a lot of the growth we’re seeing across New Zealand - not the Auckland property market - and that’s a quality upturn. With gain comes some pain

Cost of living pressures continue to siphon money out of pockets, which dilutes spending power. The RBNZ expected inflation to recede in the fourth quarter of 2025 from 3% to 2.7%. It came in at 3.1%. Food (4.3%), household energy (12.2%), and rates (8.2%) featured as major contributors. Worryingly, construction cost inflation is showing signs of turning up early in the economic cycle. Various measures of core inflation rose.

Expect household energy and cost of living to get a lot of media and political attention over the coming year, against a backdrop of a better economy. That’s going to make the election a close call. An improving economy should support the incumbents, but voters’ biggest concern is the cost of living, and 3% inflation is not voter-friendly.

Hence, good news carries a sting in the tail.

Bringing it forward

There are now growing expectations the RBNZ will be hiking rates in 2026, twice before year-end. In November, projections implied mid-2027.

With hindsight, it looks like the RBNZ over-egged the omelette when they cut the Official Cash Rate in late 2025, after getting spooked by a rogue second quarter GDP figure.

Could pending rises in interest rates choke off the long-awaited recovery? No, I doubt it.

It will temper it, though. Some support factors, such as dairy prices, have receded and the NZD/USD has bounced off its lows. Beef farmers are still happy, though. Tourism numbers continue to recover. There’s lots of optimism out there. Economic momentum is built on confidence, though it also requires substance.

You’ll see a lot of talk about the demand side of the economy, over the coming months; farm and household spending trends, housing activity, employment, business investment. They’re all relevant to watch.

However, demand needs to be met via supply. This is where things get complicated. Meeting demand comes from the supply side of the economy, which is the combination of labour and capital inputs, plus productivity. Receding migration and weak productivity growth have pulled back the supply side of the economy to 1.2%, according to the RBNZ’s latest projections. This line is usually around 2–3%. We need to get that line back up.

When you have anaemic supply side capacity, it doesn’t take much of a pickup in demand for inflation to turn up.

Hence, markets are now starting to anticipate interest rates moving up in 2026. Already, we’ve seen longer-term interest rates bounce off their lows.

The lucky country?

New Zealand’s inflation rate is 3.1%. Australia’s is 3.8%. Cue interest rate hikes across the ditch.

Unlike the New Zealand housing market (which has been stagnant), Australia’s has recovered and soared again, recording price gains underpinned by migration, which is turning into a political bunfight.

Unit labour costs in Australia, which is wages less productivity, have been rising at 5% per annum for the past four years - a recipe for inflation, which they have.

The Reserve Bank of Australia now faces a tough job. Taming inflation means dishing out economic pain. Society and politicians will not like it.

The lucky country might not be so lucky in 2026.

The bottom line

Growth is picking up and inflation is already at the top of the RBNZ’s 1–3% target range. Interest rates are too low, despite some interest-sensitive sectors such as housing failing to fire.

Conditions are improving but expect some awkwardness, and more tension over 2026, if productivity does not improve.