As New Zealand recovers from the severe weather events earlier this year, high inflation and rising interest rates have become the key headwinds for households and businesses. These headwinds are weighing on both business and consumer confidence, and this is leading to caution towards spending and investment. The upcoming general election adds to uncertainty over the general economic outlook.

Higher interest rates start to dampen demand.

There are signs in recent months that inflation is turning a corner, although inflation pressures remain intense in the New Zealand economy. Principal Economist Christina Leung says, “The Reserve Bank of New Zealand has increased the official cash rate (OCR) since October 2021, but we are only starting to see the dampening effects of higher interest rates on the broader economy. This lagged transmission of monetary policy partly reflects the substantial proportion of mortgages on fixed-term mortgage rates. With around half of the mortgages due for repricing over the coming year, we expect that as many households face significantly higher mortgage repayments, they will continue to rein in discretionary spending.”

Softer demand has supplanted finding labour as the top primary constraint for businesses. This shift suggests capacity pressures are easing in the New Zealand economy as slowing demand becomes more of a concern for businesses.

The reopening of international borders is also helping to alleviate labour shortages in New Zealand. However, there is also a large degree of speculation over the net impact of the strong recovery in net migration on inflation. While easing labour shortages will reduce capacity pressures in the economy, migrants will also add to the demand for housing and a range of goods and services.

RBNZ expects OCR to have peaked in this cycle.

Stronger-than-expected net migration and Budget 2023, viewed as expansionary for the New Zealand economy, had increased speculation that the RBNZ would increase its OCR projections at the May Monetary Policy Statement. However, the central bank surprised markets by indicating it did not expect it would have to increase the OCR further, given signs of easing inflation. “We also expect the OCR to have peaked at its current level of 5.5 percent. As households roll off historically low fixed-term mortgage rates onto significantly higher rates, we expect a further slowing in broader economic activity. This should support a further easing in inflation back towards its inflation target band of 1 to 3 percent next year.
Clearly these forecasts were wrong, and inflation was much more pervasive, which meant rates needed to rise much higher, much faster.

This unexpectedly aggressive rise in interest rates means that any bond issued in the preceding 2 or 3 years is likely to be under-water (i.e. trading below its issue price).

While it is unfortunate for those investors that hold these bonds, all is not lost. The impact of the meteoric rise in interest rates may have pushed down the current value of a bond, but those that hold to maturity will still get their dollar back at the end of the day (assuming, of course, that the company is in a position to re-pay the bond – a fair assumption in most cases).