Reality’s set in.
Welcome to the two steps forward and one step back economy. For decades we’ve become used to monetary policy reinflating the economy with ease, fuelled by the housing market and interest sensitive pockets. We’ve seen many V-shaped recoveries, where recoil is inversely proportional to the economic hit. Just pump up the housing market.
Monetary policy still carries considerable punch. The Official Cash Rate (OCR) is only now back at a level we call neutral – where the RBNZ neither has the foot on the accelerator or the brake. An OCR below 3% is pushing on the accelerator. It’s coming.
Households have also only seen around 90 basis points of effective reduction in borrowing costs so far because most people are on a fixed borrowing rate. With more than 70% of mortgages to refix in the coming months, the cheque’s simply in the mail and hasn’t arrived yet.
For now, we’ve been largely dependent on farmers driving growth, courtesy of strong commodity prices and a lower New Zealand dollar. Fonterra’s potential distribution to farmers following the sale of their consumer business is worth around 0.7 percentage points of GDP.
So why is the economy taking so long to recover this time around?
Structural challenges
Commercial gas prices have doubled in five years. De-industrialisation is occurring in some sectors. The road network isn’t in good shape. Nor is education. Our health system’s in disarray. We lack sufficient competition in many sectors which stifles innovation. You don't fix an economy overnight, especially one that’s suffered structural damage. It takes time for good policy to take hold.
Housing fundamentals
House prices in New Zealand aren’t cheap, despite falling in recent years. When something’s cheap, you can get a stronger reflationary burst. Demand for new houses is a function of population growth (natural plus migration) and building consent issuance (supply) is well above the 15,000 depicted by demand. Despite a major fall in building consents and construction sector pains, building consent issuance per 1000 residents is in line with the average since 1966. We’ve retreated from construction highs, but the level of activity is nowhere near as bad as it was during the global financial crisis.
Inflation is gobbling up some of the benefit of lower interest rates
Headline inflation is on the ascent and wage inflation isn’t keeping pace. This represents a loss in purchasing power. Double digit local authority rates and electricity inflation is siphoning money out of pockets. So, consumer confidence is weak.
Nervousness
There’s no shortage of handwringing over the global economy and impact of tariffs. Locally the 2026 election is around the corner. This is creating uncertainty: the antithesis of investing.
Changes in the supply-side capacity of the economy
New Zealand has a productivity problem. The decade average is 0.3%. It used to be more than 1%. Weak productivity means poor returns from labour and capital resources. You end up in a slow growth rut where you can’t grow too fast without generating inflation.
There are many other factors at play too but suffice to say that’s a major list.
Rather than focusing on what the challenges are, we need to look ahead. Out of despair, we’re seeing improvement, and the economic wheels are turning after a horror Q2 GDP result of minus 0.9%.
Many fundamentals are improving
The current account deficit has closed. A wide current account deficit was pushing against a domestic recovery. The recovery needed to be earnings driven and that’s precisely what we’re seeing. The mood in the regions is very different to Auckland and Wellington. We want (and are seeing) the beginning of a quality recovery, because it’s driven by the export sector and not the Auckland housing market. It’s just taking time.
The NZD is doing what it should when you need a helping hand and adjusted lower. The NZD/AUD has finally broken below 0.90 after spending years in a 0.90-0.95 zone. There’s a strong focus on costs across the business sector. That’s a necessary precursor to an improvement in productivity.
Pain brings gain in the form of reform, and New Zealand needs to see a lot of it. This isn’t just pointing the finger at the government but also many businesses listed on the NZX. A lot of value has been destroyed in recent years, and you can’t just blame the economy for it.
Polls are suggesting a move towards the political centre rather than the periphery. That could help drive some certainty and less political instability or divisiveness. We’re seeing some key personnel changes in major institutions such as the Reserve Bank and The Treasury.
The final word
When the structural foundations of the economy are shifting and have been damaged, cyclical drivers such as interest rates don’t carry their full punch. To some, this means monetary policy just needs to do more. Monetary policy cannot fix many of the problems we face though. Monetary policy cannot conjure up the 400,000 tourists we lost since pre-Covid.
Time is the great healer, in combination with good policy and a shakeup. Beware of that old growth model of selling more expensive houses to each other and relying on bums-on-seats (migration) to drive growth.