New Zealand’s economy is in recession, largely due to the RBNZ aggressive interest rate hikes aimed at curbing inflation. Contractions in recent quarters have been driven by declines in manufacturing, retailing and machinery sales.

Inflation has continued to slow but is still far off from the RBNZ’s 2.0 percent target, and capacity pressures would need to weaken further to bring inflation back to target. The effectiveness of the ongoing policy response is being hindered by existing shocks that still weigh on the economy. The RBNZ has held the official cash rate at 5.5 percent since May of last year and has signalled rates will not be lowered until 2025 given record immigration and stubborn core inflation. However, weaker than expected economic growth is likely to cause rate cuts to be implemented earlier than signalled by the RBNZ.

The economic downturn comes despite record high inward migration with over 140,000 net arrivals in New Zealand over the past year. Strong population growth may be masking the true extent of the economy’s downturn, which could have otherwise resulted in a more severe setback. Record migration has also caused the unemployment rate to rise to 4.0 percent in December, which is the highest level since June of 2021. However, unemployment remains slightly below market expectations.

There are some risks associated with the outlook for growth and inflation. Continued pressures in the domestic labour market or external shocks driving imported inflation could prompt premature monetary policy adjustments, destabilising inflation projections. Conversely, overly aggressive monetary tightening could prolong the economic downturn and push inflation below the RBNZ target. High interest rates, coupled with sluggish growth, may strain financial markets, particularly in mortgage lending. On the upside, potential growth boosts from increased migration and reduced wage pressures, as well as a quicker-than-expected decline in inflation, could facilitate earlier monetary policy easing.