Economic insights with Cameron Bagrie

Right now, war in the Middle East is undoubtedly the most significant factor in the global economic equation - but I wonder whether there’s any point writing about it when events are so far beyond New Zealand's control. Added to that, the forward curve for oil prices is downward-sloping, which means markets are pricing in a resolution of the conflict over coming months. 

The only caution is this. Markets were saying the same thing two months ago — and here we are at month four. Sure, there’s talk of “peace” from President Trump, but perhaps traders should read more history books: Vietnam, Afghanistan and Ukraine all became entrenched conflicts. Without a quick resolution we can expect downside risks to global and New Zealand growth, and upside risks to inflation. Right now the prudent are planning accordingly. 

Middle East tension is part of a wider theme: our rules-based international system is giving way to one where countries act as they please by exercising their raw power. Just-in-time supply chains are being replaced by just-in-case models, with security a dominant consideration. The New Zealand Government is now openly acknowledging this structural shift. It started before Covid and is not new — but New Zealand has been slow to internalise the new geo-political and geo-strategic reality. We received another reminder last week, with US expectations that we lift our defence spending. 

There is a great deal going on across the economy that shows this new picture emerging - so it’s worthwhile examining what I see as the most important emerging economic trends. 

Some structural elements of our economy remain positive. Farm incomes are buoyant. The lower NZD/AUD will drive a new round of export growth. Retail sales volumes have been up for six consecutive quarters — though per capita spending remains well below the 2021 peak. Residential building consents have been picking up, and migration is rising too. 

This matters because economies with forward momentum are harder to knock over when a shock arrives. Pre-conflict, New Zealand's recovery was still in its infancy — but it was a recovery nonetheless. It’s worth noting that the recovery was regional and rural-led, and we can probably expect Auckland and Wellington to continue struggling. 

Higher fuel, food, and input costs mean an economic downturn over the June and September quarters is now likely, with at least one quarter expected to see negative growth. What happens beyond that remains conditional on how long the Strait of Hormuz remains affected.

The standard central bank playbook is to look through the direct effects of an energy shock — petrol prices, food costs, transport — but to move firmly if secondary inflation takes hold. By that measure, they will be looking at rising global food price inflation with interest. 

The fact that inflation was already running at 3.1% before this oil shock doesn't help. 

The RBNZ's May decision to leave the OCR unchanged — but on a split 3–3 vote, with the Governor casting the deciding ballot — is telling. If you think you need to hike, it is generally better to move early rather than be forced to do a lot more later. Three members favoured exactly that strategy. 

Other central banks are following the same logic, acutely aware of the 1970s experience with successive cost shocks. The 2020s has now produced two: Covid, and this energy shock. When shocks embed themselves in the pricing system, they become very difficult to dislodge. Price rises get normalised.

The US Federal Reserve is the world's most powerful central bank — and it has finally shifted its tone. 

Core US inflation sits at 3–3.5% and is now trending higher. The economy is not rolling over, and unemployment remains low. Price stability is not being achieved, and now there is a cost shock to absorb. 

US interest rates are too low. 

This has helped keep the NZD/USD below 0.60 — export-friendly territory — but it has also pushed global bond yields higher, led by the US Treasury market. Japanese bond yields have hit 30-year highs. Concerns are growing about government debt positions in several countries, including the UK. 

Typically, the combination of higher interest rates and rising inflation would signal trouble for equities — but exuberance over AI is holding sway. US productivity growth ran at 2.9% over the past year. That is roughly a decade's worth of New Zealand productivity growth. 

Across the Tasman, the Reserve Bank of Australia has lifted its cash rate three times. The government is signalling a decade of deficits, headline inflation is running at 4.1%, and core inflation is at 3.5%. The lucky country is not looking so lucky. 

Having travelled a good deal in recent months, a common theme emerges: New Zealand looks pretty good in a world beset by political fracturing, populism, and rising nationalism. 

The New Zealand Government has been the near-term winner from higher inflation.

Society loses, as inflation siphons money out of pockets and wages are unlikely to keep pace over the coming year. However, while the real (inflation-adjusted) economy will take a hit in 2026, nominal GDP — volume plus price — will be higher, generating more tax revenue. Voilà: inflation helps the Government return to surplus.

That will prove to be a mirage. Inflation will inevitably pressure the spending side of the books too. For now, the Government is banking the benefit without yet seeing the cost.

The cost will come. And all political parties face the same fiscal strait-jacket heading into the election. Some will need to signal tax increases to make their numbers add up.

Jandal-nomics (that’s all about the flip flops) is alive and well. A deal one day, no deal the next. Welcome to the new world order. The US holds the world's best poker hand — economic and military strength — but not its best poker player. 

 On a positive note, the recent NZ–Singapore food-for-fuel agreement shows that paths forward can be charted through uncertainty. 

What is clear is this: inflation pressures are rising, and central banks are not going to be popular when they do what they know they need to do. 

Cameron Bagrie is the founder of Bagrie Economics and one of New Zealand's most respected independent economic commentators.