Interest rates, inflation and Trump: How a major bank thinks the economy will fare in 2025

Friday, 13 December 2024

New Zealanders have made it through a very tough financial year with high interest rates, a flat housing market and unemployment rising.

But when it comes to 2025, is it ‘new year, new me’ for New Zealand’s economy?

ASB’s economics team has looked ahead to the New Year to consider what factors were likely to have the biggest impact on New Zealand’s economy.

“It’s amazing what a difference a year makes. The general feeling was pessimistic at the start of this year and while we’re not out of the woods and challenges still lay ahead, there is a sense of guarded optimism about what’s around the corner,” ASB senior economist Mark Smith said.

Interest rates

When it came to interest rates, Smith questioned whether future drops in the Official Cash rate would be modest or substantial.

ASB was forecasting further OCR cuts of 100bps next year, including a 50bps cut in February, taking the OCR to 3.25% by the end of next year

“This should mean borrowing interest rates for households are likely to be in the 5% to 6% range by the end of 2025. The average interest rate on mortgage borrowing is assumed to end 2025 about 100bps lower than its 6.4% Q3 2024 peak,” he said.

Inflation

Inflation in New Zealand with tradeable CPI prices had already fallen about 1.5% over the year with ASB estimating CPI inflation will end the 2024 calendar year virtually at the midpoint of the RBNZ’s 1-3% target.

But, ASB anticipated annual CPI inflation would modestly rise to 2.6% by the end of 2025.

“The return to low and stable inflation will make it easier for firms, household and government to plan and invest, helping to grow the economy.”

Lower inflation combined with falling interest rates is also taking pressure off household budgets.

“To put it in context, during the peak of the COVID-19 pandemic, households were facing annual increases of more than $100 per week in living costs. In 2024 this slowed to an extra $30 per week and in 2025 we believe it will shrink to less than an extra $10 per week,” says Smith.

Housing market and consumer spending

But whether falling interest rates and inflation and an easing in cost-of-living pressures will be enough to drive a consumer spending and housing market rebound at a time of rising unemployment was still questionable.

Household spending volumes were expected to end 2024 about 6% below early 2022 peaks on a per-capita basis, and household net worth and house prices was likely to end 2024 about 20% below late 2021 peaks in inflation adjusted terms.

But Smith said there was reason to be hopeful for next year.

“The moderation of inflation will ease pressure on household and business budgets while lower interest rates should help to kick-start greater spending in the retail, wider services and construction sectors which should in turn support labour incomes and cap the 2025 lift in the unemployment rate,” he said.

“Lower interest rates should also provide a welcome boost to the housing market and we expect house prices to rise by 5-10% over 2025, although we don’t expect these to surpass the record peaks we saw in 2021 until 2026.”

Trump

President-elect Donal Trump may also have an impact on the New Zealand economy, but how much of an impact remained questionable.

The US is New Zealand’s third largest trading partner so its trade policies under Trump will be of the greatest concern to Kiwi exporters, Smith said.

If proposed tariffs are announced, the impact will depend on their size, how long they are imposed for, and how targeted they are and the response of other countries, particularly China, will also be key and could impact global growth if they are retaliatory.

“That said, if we learnt anything the first time around, it’s to expect the unexpected and with Trump already having changed his view on tariffs, these could simply be a negotiating tactic – time will tell.”