OECD Economic Outlook, Volume 2023 Issue 1

New Zealand

Real GDP growth is projected to ease to 1% in 2023 and 1.2% in 2024. Private consumption is set to weaken due to lower employment growth and rising mortgage-servicing costs. Higher interest rates and declining house prices will weigh on investment. Unemployment is expected to increase throughout the projection period, on the back of weaker activity growth. The slowdown in demand, increasing spare capacity and stabilising energy prices should gradually reduce inflation through 2023-24.

Inflation remains well above the central bank’s target range and, together with still elevated medium-term inflation expectations and rapid wage growth, requires monetary policy to remain restrictive. Public debt has risen substantially in recent years and fiscal consolidation should continue to ensure that the government is on track to meet its 2026 operating surplus target. This will also help reduce inflationary pressures. Reforms that strengthen ICT skills supply are essential for sustainably boosting productivity and growth.

The economy is beginning to slow amid policy tightening

Economic activity is beginning to slow amid high inflation and rising interest rates. Private consumption has held up well, owing to high employment, but investment, especially residential construction, has weakened. Business sentiment remains subdued. Forward-looking indicators point to a softening of labour market pressures, with a lack of demand overtaking labour shortages as the most important factor limiting output. Inflation remains high and broad-based. In the first quarter of 2023, year-on-year headline consumer price inflation eased but was still 6.7%. Core inflation continued to rise, reaching 6.8%, fuelled by strong growth in wages and service prices. Inflation expectations are also still high but have started to decline, especially at the two-year horizon. The extreme weather events that hit New Zealand’s North Island early in the year caused severe damage to local communities and infrastructure, including important highways. Production losses were concentrated in the primary sector, likely leading to upward pressure on food prices and lower agricultural and horticultural exports. International tourism arrivals have recovered rapidly, and net immigration is high, which will also contribute to inflation in the short run. Elevated global commodity and energy prices have contributed to strong imported inflation. The direct implications from financial volatility in the US and Europe have been limited, as domestic banks have sound liquidity and have taken on relatively little interest rate risk.

New Zealand: Monetary and activity indicators

1. Average new standard mortgage rates advertised by registered banks in New Zealand.

Source: Reserve Bank of New Zealand; and Statistics New Zealand.

Statlink

New Zealand: Demand, output and prices

Statlink

Macroeconomic policies are tightening

Macroeconomic policy is shifting quickly to a restrictive stance. The Reserve Bank of New Zealand (RBNZ) raised the Official Cash Rate (OCR) by a further 25 basis points to 5.5% in May, stating that this would increase confidence that inflation falls back to the midpoint of the 1-3% target band. This brings the cumulative policy interest rate increase to 4.75 percentage points since the beginning of 2022. The OCR is expected to remain stable until mid-2024 before starting to decline. Tightening of the fiscal stance is expected to reduce the underlying fiscal balance by 1.2 percentage points of GDP over 2023 and 2024, reflecting plans to keep new spending growth modest to meet the target of a return to budget surplus by 2026. A lower reduction in the headline balance is expected due to below-trend economic growth and the fiscal cost of recovering and rebuilding following the North Island weather events. The temporary cuts in petrol excise tax, road user charges and public transport fares introduced in 2022 were extended further to end-June at an estimated cost of NZD 718 million (0.2% of GDP) for March to June 2023.

Economic growth is projected to weaken

Real GDP growth is set to slow sharply this year, mainly owing to weakening domestic demand. Rising debt servicing costs, falling housing wealth and a softening labour market will hold back household consumption although high migration will temper the slowdown. Business and residential investment will contract due to tightening financial conditions, declining house prices and easing demand. The recovery in international tourism and stronger Chinese growth will help export growth pick up. Unemployment is set to increase gradually over the projection period, due to moderating economic activity and a growing labour force due to population growth. Inflation will slow but remain firmly above target in 2023 before falling further in 2024, as aggregate demand stalls and an increasing labour supply alleviates wage pressures. Key risks include lower-than-projected wage moderation, and the occurrence of more extreme weather events, both of which would boost inflation and hamper growth. The housing market slowdown could also be sharper, more prolonged and involve higher mortgage payment defaults than expected. On the upside, stronger-than-expected tourism and migration inflows would be a boost for growth but also slow disinflation.

Reducing inflation is a pre-requisite for a sustainable recovery

After a rapid and large tightening of monetary policy, it is time to monitor whether the substantial rise in interest rates is sufficient to cool excess demand pressures and durably reduce inflation. To reduce the risk of further policy tightening, it is important that the government sticks to its plans to increase overall spending only moderately, helping to cool demand. This will be challenging given extra spending pressures arising from the need to repair infrastructure and other severe weather damage. The reversal of cuts in petrol excise tax and road user charges cuts from July will help make some room for this weather-related expenditure. Indexation of the main social benefits to average wage growth will help provide protection against higher energy price rises for those on lower incomes. Any additional future energy support should be very tightly targeted based on income and vulnerability to higher energy prices and encourage energy saving. Restoring macroeconomic stability should be accompanied by a structural reform programme strongly focused on improving economic performance through digitalisation. This requires improving ICT skills supply, including by encouraging women to pursue digital careers through greater participation in mathematics education, and making it easier for small firms to reap the rewards of digitalisation through lower barriers to participate in government procurement of IT and greater support for exporting digital services.