Macroeconomic update: is it all doom and gloom?

By Liza Van der Merwe, Ayden Dickins and Lilly van Keulen

On 14 August there was a crucial turning point in the economic environment, with the Reserve Bank of New Zealand (RBNZ) delivering a long-awaited cut more than six months earlier than indicated back in May. Following this news, conversation quickly pivoted from recession to the other ‘R’ word – ‘recovery.’

The question on everyone’s minds is ‘when will our economy recover?’ and the short answer is that conditions are set to improve, but slowly. We continue to face a challenging outlook over the rest of 2024, but there’s hope that the RBNZ rate cut has set the tone for 2025 and beyond. Since August, retail interest rates have fallen, the yield curve has ‘un-inverted’ itself, and the net percentage of businesses expecting an improvement in economic conditions is at its highest level in a decade.

The stage for recovery is now set – but the big question is: how will recovery play out?

Where is our economy at?

Over the past five quarters, three have seen the economy shrink in real (inflation-adjusted) terms. While there was growth in the March quarter, it’s expected to be flat or even negative over the next two quarters. Underlying this mediocre headline is a prolonged contraction in per-capita terms. The current weak economic growth is driven by weak consumption and business investment, which in-turn has been driven by the high interest rate environment.

The impact of this weak performance is different across sectors. Some, such as construction, have been hit hard. Construction growth was flat at -0.1% in the year-to-June 2024, because of the high interest rate environment. Other sectors reliant on consumer spending, such as retail trade, are also much weaker compared to pre COVID-19 levels.

The household crunch continues

The squeeze this environment has placed on households lies at the heart of New Zealand’s weak economy – and while the outlook is improving, it will take time for households to recover.

Yields on mortgages, a measure of the average interest rate paid by households with mortgages, has risen from 3.68% in April 2022 to 6.3% in July 2024. While the OCR hasn’t increased since May 2023, the effective (average) mortgage rate paid by households continues to increase, highlighting the critical lag in how movements in the OCR transmit through the economy.

The RBNZ joined some central banks globally moving from a hiking cycle to a cutting cycle and dropped the OCR to 5.25% in its August meeting. This indicates pressure on households may start to ease. with a 100-bps cut by next year June. But what we need to get economic activity back on track is a more aggressive cutting cycle. The large number of fixed-term mortgages in New Zealand means movements in the OCR have a delayed impact on households, with 72% of mortgages due to be repriced over the next 12 months.

Consumer confidence has improved over 2024, but high mortgage rates and a rising unemployment rate have kept overall consumer confidence subdued. Household confidence will begin recovering as retail mortgage rates fall, but it will take time for this to flow through to spending.

Recovery is likely to be slow

The drop in the OCR reflects easing inflationary pressure in New Zealand. While inflation is nearing the target band of 1-3%, it has been slow to fall, largely due to non-tradeable inflation. This stickiness has been driven by increases in council rates, insurance and rents, aspects that the RBNZ cannot arguably control and proves resistant to softening economic conditions.

Business confidence has started to recover with the ANZ Business Confidence index at its highest level in a decade. This reflects improving business sentiment; however, the business confidence index measures whether businesses think economic conditions will improve from where they are now in the next year. Coming out of a technical recession, the bar for economic improvement is low.

Additionally, the same mechanisms which delayed the impact of OCR hikes on households, will delay the impact of OCR cuts on households. Timing which could be the difference between navigating a ‘soft-landing’ and over-engineering an excessive and painful economic downturn.

There are green shoots of opportunity from this slow economic landscape

While the overall picture has been bleak, we have seen brighter areas of the economy across the downturn.

Tourism is looking particularly bright, with visitor numbers back to 85% of pre-pandemic levels, bringing relief to some regional economies and the sectors hardest hit by the pandemic.

Healthcare and logistics are seeing resiliency, despite weak consumer spending and confidence, and a high interest rate environment. Going forward, we expect resiliency in sectors energy transition, technology, TMT, health and FSI, and over the medium term, the consumer sector, focusing on sustainability.

And not all households are facing the same crunch. While mortgage-burdened households may be facing tough times ahead, households without mortgages or only small mortgages will begin to see the cost of living stabilise and be in a position to lead the economic recovery. Although the latter may be impacted by soft house price growth.

Advice for our Deloitte Private clients

Hard times are nothing new to New Zealand’s small business sector. Those who can show resilience and see and grasp the opportunities clouded by the overall economic outlook, will be well positioned for prosperity as the New Zealand economy starts to recover.