Economic Recovery for A/NZ Continues to Unfold

The cautious optimism about an economic recovery is translating to broader strength, particularly in Australia but also in New Zealand.

While serious uncertainties dominate the global outlook relating to geopolitical threats to markets and economic activity, particularly from the Middle East, domestic drivers of the economy are broadly positive. A combination of prior interest rate cuts, moderate fiscal stimulus and higher commodity prices have helped spark the more positive tone.

Inflation remains above target which is posing some policy challenges for both the RBA and also the RBNZ. The RBA, in particular, is grappling with the time it will take to see inflation return to target and as a result, it retains an inclination to further increase interest rates following on from the February hike.

Monetary policy settings overseas remain caught between ‘on hold’ and the ‘possibility of further cuts’. The near term inflation and economic growth momentum will help determine whether this relative calm can be sustained. Over the longer run, markets are looking for a gentle interest rate tightening cycle.

Australia

GDP rose 0.8 per cent in the December quarter for an annual rise of 2.6 per cent. This was the fastest pace of economic growth since 2016 (aside from the COVID pandemic). There was also confirmation of a pick up in productivity growth which in 2025 was 1.0 per cent, the strongest result (outside the pandemic) in 8 years. Helping the inflation fight, real unit labour costs actually fell 0.1 per cent in the year.

Annual headline inflation was 3.8 per cent in January, unchanged from December. The trimmed mean (underlying) inflation rate ticked up to 3.4 per cent from 3.3 per cent to remain above target.

Business investment continues to recover, rising at an annual pace of 5 per cent in the December quarter. Dwelling construction is surprisingly weak, having fallen 15 per cent since September. The implied shortage of housing will remain in place whilst ever new construction remains weak. After a solid lift in the latter part of 2025, household spending growth is consolidating at a steady pace.

The news on the labour market is mixed: the unemployment rate was low at 4.1 per cent in January, but growth is employment has eased to a 9 year low, the participation rate has dropped 0.5 points to 66.7 per cent and the number of job vacancies remains consistent with a softer jobs market.

At the same time, annual wages growth was steady at 3.4 per cent in the December quarter having been around this pace for the past year. With productivity growth at 1 per cent, this level of wages growth is consistent with inflation returning to the mid-point of the RBA target.

The RBA hiked interest rates in February in reaction to the upside surprise in inflation and the more positive tone of private sector demand. While RBA Governor Bullock continues to avoid giving guidance on the outlook for monetary policy, markets are pricing in a peak cash rate of 4.25 per cent in 2027 from the current 3.85 per cent rate. Market pricing can be volatile and can move with new information. The current global uncertainties will have significant implications for monetary policy.

New Zealand

There are encouraging signs that the recovery from the early 2025 recession is gaining breadth and momentum. Retail sales volumes rose a strong 0.9 per cent in the December quarter to be 4.4 per cent higher in annual terms. This is underpinning a strong rebound in bottom line GDP. Business confidence surveys are unambiguously upbeat about the economic outlook.

While the unemployment rate reached a decade high of 5.4 per cent in the December quarter in a lagged response to the earlier economic weakness, employment rose moderately. The number of job vacancies has risen solidly from the cyclical low in the middle of 2025.

With inflation above the target and further signs of economic recovery, markets are expecting the RBNZ the tighten monetary policy towards the end of 2026 and through 2027. Approximately 100 basis points of rate hikes are priced in over the next 12 to 18 months.

Currencies

The AUD has been a star performer in currency markets, rising to around 0.70 US cents and it has firmed on most cross rates. The generally positive economic tone and high bond yields for a AAA credit rated country has attracted strong capital inflows. Stronger commodity prices have also been positive for the AUD

The NZD has been broadly stable at around US 59 cents, despite the economic turning point. The AUD/NZD cross has risen to a 13 year high of 1.19 with Australia’s on-going relative economic outperformance and more stable budget settings helping to drive this movement.