Happy anniversary! It’s officially been one year since the Reserve Bank (RBNZ) began easing interest rates at its infamous “U-turn” meeting in August 2024.
At the time, there were hopes the cuts to the Official Cash Rate (OCR) would flow through to the real economy faster than usual, as a high proportion of mortgage rates were fixed on short terms.
It’s not clear that has happened. Many feel the economic recovery has not been going well.
Households have not resumed spending, asset prices remain stalled, unemployment is still rising, and businesses say they are confident but refuse to hire or invest.
To make matters worse, the cost of many household essentials has continued to climb, even as core inflation pressures ease.
The lack of progress has piled political pressure on Christopher Luxon’s government, with voters frustrated and columnists banging their drums for a leadership coup.
Much of this is based on vibes. Until the most recent quarter, the NZ economy was performing slightly better than the RBNZ had forecast when it began cutting rates in August 2024.
High-frequency data suggests momentum was lost in the June quarter, though it is unclear whether this is a temporary blip or something more lasting.
Still, businesses and households who were told to “survive till ‘25” are upset to find the catchphrase should have instructed them to survive through 2025.
Monetary policy typically takes 12–18 months to have its full effect on the real economy.
The first rate cuts intended to support recovery are only just arriving today.1
This is a slight oversimplification. Some impacts, such as those in financial markets, are immediate, but the full chain reaction takes more than a year to flow through to spending, inflation, and employment.
In that sense, it is not surprising the Coalition’s short-term economic strategy, which depends on central bank interest rate cuts, has yet to deliver much success.
But the anxiety is understandable, as some links in the monetary policy transmission chain don’t appear to have activated in the way RBNZ theory might predict.
Chained reaction
Monetary policy transmission works like this: the central bank lowers the OCR, which causes market and mortgage rates to fall. This reduces borrowing costs and lifts asset prices.
Businesses and households then use their stronger financial position to spend and invest, expanding economic activity, creating jobs, and starting a virtuous cycle of growth.
New Zealand still appears to be at the first stage of this process. The OCR has been cut 225 basis points to 3.25%, and new mortgage rates have dropped 150 points to about 5.5%.
But most borrowers are not yet on the lower rates. RBNZ data shows the average yield on bank mortgages was 5.7% in June, down just 66 basis points from its September 2024 peak.
Yen Nguyen, an economist at ASB, said nearly half of mortgages are expected to refix this calendar year,2 which would drag the average rate close to 5% and free up spending money.
“This should provide some relief to households, offering extra savings; however, this buffer is being eroded by rising costs, especially for food and housing,” she said.
As a result, cautious consumer spending is likely to continue throughout the year, and at a much slower pace than many had forecast. This suggests the economy has so far responded only slowly to looser monetary policy.
Household debt-servicing costs as a share of disposable income were still 10.1% at the end of March, down from 10.5% at the peak of monetary policy pressure in September 2024.
This ratio remains among the highest levels in the past 15 years. It was 7% before the pandemic and dropped to as low as 5% in late 2021.
Perhaps as a result, house and other asset prices have not risen in response to lower interest rates, though market activity has picked up and prices appear to have stabilised.3
Still, Quotable Value’s house price index shows no change in the 12 months to July 2025, meaning households do not feel any wealthier and have less access to credit.
This suggests the “wealth effect” transmission channel has not been activated, and there is no price signal in the market to encourage the housing construction the RBNZ might have expected to come bounding back.
Borrowing costs are the most-discussed transmission channel, but there are others.4 For example, lowering interest rates should weaken the NZ dollar and boost export volumes and prices.
The currency has fallen about 5.5% against its key trading partners since July 2024, and the export sector has performed well. However, this channel has been clouded by the global trade war and may be more muted in the future.
Watching the clock
In a recent note, Westpac NZ economists said the lags between lower interest rates and their impact on the economy are long, and are likely to have their most tangible effects in the next 6–12 months.
The pass-through of rate cuts to date has been gradual, but should provide a “sizeable boost to households’ disposable incomes and demand more generally over the next 6 to 12 months.”5
The RBNZ’s monetary policy handbook warns that various economic factors “may alter or override the transmission of monetary policy.”
Transmission is more complex than these simple models suggest, and even “small shifts in the composition of key economic variables can have unanticipated consequences.”
This makes it hard to judge whether interest rate cuts so far have been “working.” It appears New Zealand is still in the early stages of the chemical reaction.
Has transmission stalled, or is it just slow? Which stage in the chain should we have reached by now? Has monetary policy lost its potency, or has the lag simply grown longer?
Only time will tell; In the meantime, we watch nervously for the next domino to fall.
Footnotes:
1 Monetary policy transmission starts when market interest rates move in anticipation of policy changes, not when they are actually implemented. This effectively means policy easing started in July when the RBNZ first signalled the U-turn.
2 This is true at almost any given time, as fixed rates are constantly rolling over. But it becomes more important when the mortgage rates on offer have changed significantly.
3 Prices are partly stagnant because so many houses are up for sale right now. Demand has been picking up and many economists think prices will start to rise 4% or 5% once the backlog has cleared.
4 There’s also a credit channel, where lower rates help banks lend more and make it easier for borrowers to access debt, and an expectations channel, where confidence about future rates and economic conditions prompts households and businesses to spend and invest sooner.
5 Of course, New Zealanders may choose to save (rather than spend) this disposable income and rebuild their post-pandemic balance sheets, just like the Government. This would be what economists call a “balance sheet recession”.
*This article was first published in our email for paying subscribers. See here for more details and how to subscribe.