David Hargreaves examines the prospects for a New Year that appears to offer a lot - but in both potentially good and bad ways

Normally, when previewing a New Year, I stick to New Zealand-specific issues within our control. And I will (mostly) do that again this year.

It is, however, impossible to ignore the incredibly volatile global backdrop. Any number of issues could trip us up in 2025. (Tariffs, conflicts, political instability etc, etc.)

I think it would be a mistake to start second-guessing. We should just play the cards as they are dealt to us.

Volatility may offer opportunities as well as threats. We need to be vigilant. Much of that will hang on our government. Spot the dangers and the opportunities as they emerge, and deal with them. But don’t second guess – as I think too many observers and commentators are inclining towards.

That’s the substantial health warning out of the way. The following are some of the things I’m looking out for in New Zealand for 2025.

Ending 2024 with an inflation rate back in the 1% to 3% target range was a big deal. Can we keep it there though? (My detailed review of 2024 is here.)

Domestically generated inflation remained a concern through the past year. The so-called non-tradable rate was a still-elevated 4.9% as of the September quarter.

While some say the Reserve Bank (RBNZ) shouldn’t fixate on the domestically sourced inflation rate, the fact is it DOES worry about it and this concern influences the Official Cash Rate (OCR) settings.

If the RBNZ remains worried that domestic inflation pressures could continue we may yet see less interest rate relief over the coming year than hoped.

Imported, so-called ‘tradable’ inflation was running at -1.6% annually as of the September 2024 quarter. That’s the main reason our ‘headline’ rate dropped to 2.2%.

With the aforementioned potential global volatility this year, we can’t depend on low offshore inflation.

The RBNZ attempts, as much as possible, to ‘look through' one-off shocks to international inflation.

If, however, the effects prove ongoing, such as we saw with the global supply chain shock during the pandemic, then the impact becomes too great to ignore. And OCR action is needed.

So, whether inflation will stay in the 1% to 3% range is something to be watched. And this is obviously vital in what transpires with the OCR and with retail interest rates. And by implication with the whole economy.

The OCR will start 2025 at 4.25% and the RBNZ has given (surprisingly strong) indications that it will be reduced to 3.75% at the next review on February 19.

How low will it go?

How much lower will it go during the year? And, importantly, how much of the OCR reductions will be passed on by banks in borrowing and deposit rates?

The banks took on a front-running role in the second half of 2024, cutting rates even before the RBNZ began dropping the OCR in August.

New mortgage business for the banks has been sluggish in the past three years – certainly when compared with the roaring business they saw during 2020-21.

They have been keen to attract as much new borrowing as they can. But they won’t want to see the margin between what they lend money out at and what they borrow it for trimmed too much for too long.

We shouldn’t therefore assume bank interest rate reductions will exactly mirror the magnitude of OCR reductions over the next year.

According to the RBNZ about one-third of Kiwis have mortgages. So, lower mortgages will be significant in terms of what people can spend in 2025 and how this will stimulate the economy.

We should not, however, overlook the impact of deposit rates either.

In the period from 2019-21 the amount held with banks by households on term deposits dropped by over $20 billion as barely-existent rates of return prompted investors to look elsewhere.

Since the rise in interest rates after the middle of 2021 an extra $60 billion, which is a lot, has been tipped into term deposits by Kiwi households.

At what point now, however, as deposit rates drop, do people start looking around for somewhere else to park their money? And where do they park it?

Money looking for a home

Housing is usually the obvious answer in New Zealand.

Falling interest rates have a push-pull effect for depositors. They push them to put their money somewhere else. Lower mortgage rates ‘pull’ these same depositors into buying houses.

The first home buyers (FHBs) have been strong in the housing market over the past three years while the investors, particularly, have been pretty much sitting on the sidelines.

The attitude of investors will therefore be crucial for the market in 2025. Already there have been signs of a rise in activity (but from a low base) by the investors.

The RBNZ is forecasting 7% house price growth in the year.

But there are complications.

Rentals have flattened in recent times after strong gains through 2023. Just looking around Auckland suggests there’s a lot more inner-city accommodation available now than there was. Inbound migration reduced this year, which is likely a big reason. Outbound migration surged this year and is likely another factor.

Also, the RBNZ is now fully equipped with macro-prudential tools, having put in place debt-to-income restrictions (DTIs) this year to sit alongside the existing loan-to-value ratio (LVR) limits.

Investors will be encouraged by lower interest rates and by supportive government measures such as the restoration of interest deductibility and the lowering of the bright-line test threshold back to its original two years.

Against this is an uncertain outlook for rentals. And what sort of combined impact might the DTIs and LVRs together have as interest rates get lower? And then there’s migration. Will young people keep leaving in the same sorts of numbers as left this year? If they do, what happens to all the would-be first home buyers? What happens to homes that were bought by those migrating?

Ultimately the biggest issue for 2025 will be how quickly the economy begins to recover from the impact of the high interest rates.

Can we fix it?

Normally recessions come from some naturally occurring blow to the economy. The recession we’ve just had was engineered by the RBNZ. Does that mean it’s easier to fix?

The psychological impact of the interest rate reductions so far has seen a big improvement in the mood of the country. Business and consumer surveys are showing much greater confidence.

However, I think a still unanswered question is how much lasting damage has been done by the high interest rates. A concern throughout the 2021-23 OCR hiking cycle was always that people may have been doing it tougher than they let on.

It’s still possible therefore that the RBNZ ‘overcooked’ the rate hikes and the damage is greater than we might like to think.

Confidence can be brittle and easily knocked. So, it is still by no means clear that the upticks we are seeing in intended activity - as expressed, for example in business surveys - will convert to actual activity as 2025 progresses.

Okay, so plenty think about.

There is much more that could be said about a year to come that might really offer anything - both positive and negative.

The above, however, are the key things I’m looking out for in 2025.

Many ‘ifs’ cloud the picture.

If inflation stays under control, we can see interest rates continue to come down.

And if that happens spending may increase and the economy may start to move again.

But ‘if’ something untoward does happen internationally then this could blow everything off course.

As I said at the start though, we shouldn’t second-guess. We just need to carry on and do our thing. And hope that we end up with a better year than the one we’ve just had.

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