BNZ economists say a solid bounce in economic activity is expected in the second half of next year, but in the meantime there is more pain to be felt as the economy bounces along the bottom - torn between rising immigration and higher interest rates

The New Zealand economy is currently "in peak stagflation", according to BNZ head of research Stephen Toplis.

In a New Zealand at a Glance publication, Toplis highlights the fact we've just had two quarters of negative economic growth, a labour market that is "unsustainably tight" and inflation "miles above" the Reserve Bank’s 1% to 3% target.

"But the worm is turning," he says.

"Inflationary and labour market pressures are easing, and interest rates have probably peaked. The outlook is brightening with a solid bounce in activity expected in the second half of next year.

"In the interim, however, there is more pain to be felt as the economy bounces along the bottom - torn between rising immigration and higher interest rates. And, of course, politics takes centre-stage as the General Election approaches."

Annual inflation as measured by the Consumers Price Index (CPI) hit a peak of 7.3% last year and as of the March quarter of 2023 was at 6.7%. The Reserve Bank (RBNZ) has been hiking the Official Cash Rate to take the heat out of the economy and the sting out of inflation. The OCR has been raised from just 0.25% at the start of October 2021 to 5.5% - though the RBNZ's indicating 5.5% may be the peak.

Toplis says the final six months of this year will be "particularly problematic" as the household sector "succumbs" to the full weight of past RBNZ cash rate increases.

"At the same time, businesses will continue to face into margin compression and weakening demand, especially for goods (as opposed to services). And with businesses already under pressure, uncertainties about the outcome of the October General Election will likely result in investment activity being postponed."

He says the October 14 General Election is shaping up to deliver one of the closest in a long time.

"Ultimately, the minor parties will determine the outcome with the only certainty being we will not return a single party majority, as is now the case. Given that the policy prescriptions of the potential governments are quite different, and given the uncertainty of the outcome, investment activity is expected to be postponed until after the election. This increases the potential for the economy to contract in the second half of this year."

Toplis notes that the RBNZ Monetary Policy Committee has said the tightening cycle is now "done and dusted".

"We have no reason to disbelieve it. Inflation looks set to fall relatively quickly from here on and the labour market is easing. From our perspective, its now a question of when and how much does the OCR fall.

"Our central view answers this with a first cut in May 2024 and then the OCR progressively falling in the two years thereafter. At this stage we have a low in the cycle at 2.5% but there is a very real chance the trough will end up in the 3s," Toplis says.

On the currently "soaring" net migration, Toplis says on an annual basis, New Zealand reported a net inflow of more than 72,000 people in the year ended April 2023. A year earlier it was an outflow of 19,000.

"We think the annual inflow will peak at around 100,000. There are two very big questions surrounding these flows. How long will they last and are they inflationary or deflationary?

"For now, we believe the impact of the surge in supply in moderating labour market tightness and, hence, wage growth is more disinflationary than is the demand side’s inflationary effect. But if net migration maintains its current pace, then demand side effects will start to dominate.

"Most forecasters are assuming the pace slows but, in all truth, no one really knows. Watch this space. It is important!"