Article originally published 6 October 2026 by the NBR.
- New Zealand’s recovery remains uneven, with significant spare capacity, cautious households and housing-market weakness limiting domestic momentum.
- Export strength and investment offer a credible path to broader growth, while easing inflation could reduce the need for the OCR to reach the peak currently priced by markets.
- The pace of recovery and the interest-rate outlook have important implications for New Zealand bonds and equities, although the share market is not a direct proxy for the domestic economy.
Not out of the woods: Recovery interrupted by renewed tightening
The NZ economic recovery since the end of 2024 has been exceptionally uneven and in aggregate, disappointing. We probably all remember the phrase “Survive ‘til ‘25” that was used throughout 2024 to capture the idea that the economy would improve. Much of that assumed improvement was predicated on the Reserve Bank of New Zealand (RBNZ) lowering interest rates from the cycle-peak of 5.5%. While the RBNZ did begin to cut interest rates in August of 2024, policy settings remained restrictive for a year after that and continued to have a downward force on the economy.
It’s useful to continue to recall the volatility of policy settings. Monetary conditions briefly entered “loose territory” in October of last year when the RBNZ cut the Official Cash Rate (OCR) by 50 basis points (bp) to 2.50% which was followed by another reduction in November to 2.25%. However, the inflationary impact of the Iran War took CPI to more than 4% in Q2 this year and has meant stimulatory policy didn’t last long. The RBNZ lifted the OCR in July and September by 25bp each time to 2.75%. Financial markets were quick to anticipate an aggressive tightening cycle that takes the OCR to almost 4% by the end of 2027. These market expectations are already being reflected in higher retail interest rates that are reducing households’ ability and desire to consume, along with increasing the cost of borrowing for businesses.
NZ GDP growth since the end of 2024 has been volatile and growth has been largely attributable to our export sector and an improvement in business investment, from a low base. The average quarterly growth rate over the past year and a half has been 0.5% - marginally ahead of the RBNZ’s estimates of potential output growth. While this has allowed for a small reduction in spare capacity in the economy, a significant amount remains. The RBNZ’s output gap estimate, i.e. the level of economic output relative to what can potentially be produced, is around -1.5%. Perhaps a more intuitive example of spare capacity is GDP per capita which remains around 2% below the 2022 peak.
Given our lacklustre aggregate economic performance over the past couple of years, the catch phrase for our economy has increasingly shifted to something along the lines of “Survive ’26, thrive in ‘27”, particularly in weaker areas of our economy like consumption. But the question that many people have in response is how can our economy “thrive” without the support of monetary policy?
Why households may struggle to drive growth
The most pessimistic view you might hear is simply that our economy can’t thrive given the high degree of consumer caution. Mortgage rates are already back to above 5% for most fixed terms and above pre-Covid levels. The unemployment rate is high at 5.6% and is being accompanied by slow wage growth and elements of job insecurity. Likely reflecting this challenging and uncertain backdrop, household savings rates have picked up.
Weakness in the housing market has added further downward pressure to consumption. House prices have been flat for two years and show little prospect of gains given both the likely adjustment from an over-valuation and the low amount of house sales relative to listings. Like it or not, housing has been an integral part of how we generate economic growth. As house prices rise, consumers who own houses (around two thirds of the population) feel wealthier and are happier to spend. Turnover in the housing market also tends to pick up when house prices are rising. This increased turnover brings with it the purchases of new whiteware and furniture, for example that provides a boost to retail sales. Higher house prices also encourage residential investment and benefit the construction industry.
With consumption making up roughly two thirds of GDP, a strong economic recovery would require exceptional contributions from the remaining components. Of these, government spending is clearly constrained by the need to return the fiscal balance to surplus over the next 3-4 years. That leaves the export sector and investment to expand significantly to sustain overall economic growth. Given the various global risks at present, for example high oil prices and interest rates, what confidence can we have in ongoing demand for our exports?
Export strength offers a path forward
A more measured view, and one the RBNZ appears to have adopted, is that the recent strength in the export sector will increasingly lift activity in other parts of the economy and moderating inflation means the OCR doesn’t need to be lifted to the market-implied peak of 4%. The export sector has enjoyed the enviable combination of solid demand from our trading partners and high prices for our commodity exports, particularly dairy and meat. This resilience in external demand has continued despite high oil prices. The tourism sector also appears to be benefitting from the combination of a resilient global economy that gives prospective travellers the willingness and ability to travel, alongside a weaker NZD that makes us a cheaper destination. It’s reasonable to assume that some of this combined export strength will benefit the domestic economy. Additionally, investment in infrastructure, especially renewable energy and the electricity grid, along with new sectors such as space and biotechnology are positive economic growth influences.
But there is more to the story, the RBNZ also assumes consumer purchasing power will improve as inflation moderates and the labour market will respond positively to better economic momentum. In this scenario, the moderation in inflation means the RBNZ may not have to take the OCR anywhere near the 4% peak implied by markets and could see lower term interest rates as markets re-price closer to the RBNZ’s September MPS forecast of a 3.25% peak. These lower interest rates would likely provide another leg of support for consumption and housing.
A more optimistic ‘Goldilocks’ scenario
An optimistic take could be one where oil prices drop, meaningfully improving household cash flow and allowing the RBNZ to take its time in lifting interest rates further. This “goldilocks” scenario is one where the global economy also benefits via the same channels. As such, the export sector would likely continue to do well and the domestic economy would be in a better position to provide additional support to growth. Household consumption would likely pickup as cash flow improved via lower interest rates and the drop in fuel prices. Further support would probably come via higher house prices and possibly increased certainty.
What the recovery means for bond investors
The speed and extent of our economic recovery hold important implications for NZ asset prices. In the case of fixed income, NZ yields have increased to historically high levels in response to central bank rate hikes, higher oil prices and global issuance concerns. The yield, for example on the benchmark NZ bond index (the NZ Composite Investment Grade Bond Index) is around 4.7%, the highest in more than 2 years.
An increasingly hawkish US Federal Reserve, under new Chair Kevin Warsh has played a role in lifting interest rates globally, including in NZ. NZ bond yields are particularly sensitive to US yields, moving on average around 7bp for every 10bp movement in US yields. The Fed recently lifted the Fed Funds target range by 25bp to 3.75-4.00% for the first time since the middle of 2023. Markets anticipate an additional 100bp of Fed rate hikes over the coming year. Questions about US fiscal sustainability have added further upward pressure to global yields given the status of the US as a safe-haven and of the US 10-year Treasury yield as the global risk-free reference interest rate. US 10-year term premia, for example, which estimates the compensation provided to investors over cash to lend to the US government for 10 years is approaching 100bp, from being less than 50bp in February this year. Additional focus on issuance has come via the AI hyperscalers that are increasingly reliant on debt funding to deliver necessary capital expenditure.
At home, the RBNZ has also started a tightening cycle in response to higher energy prices but our economic growth, however, is nowhere near as strong as the US. Our government is also on a much more sustainable fiscal trajectory, committing to returning the fiscal balance to surplus over the next few years. While the outcome of the upcoming election may impact the exact timing of when the NZ fiscal balance returns to surplus, the level of NZ bond yields is proving attractive for many investors from both an income point of view and the potential ability to protect portfolios in the case of a negative demand shock.
Why the share market is not the economy
For NZ equities, the first thing to note is that our share market is not the economy, with perhaps less than half of the index sensitive to changes in domestic activity. It’s not to say that the strength of our economic recovery, or lack thereof, won’t impact some parts of our equity market, just that there are some important features to bear in mind. Firstly, almost 40% of the NZ equity index revenue is generated outside of NZ and 15% of revenue is generated outside Australasia. Secondly, the index has a large weight to utilities (at around 17%) which tend to be more defensive given greater certainty of income and therefore, dividends. Thirdly, the composition of the index is also heavily influenced by a large weight to one company – Fisher and Paykel Healthcare at almost 20%. Finally, the latest NZ earnings season offered insight into the way companies are still able to beat earnings expectations during challenging economic times via “self-help” initiatives designed to reduce costs and improve productivity.
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