NZ Economy: Iran War, Inflation Fears & Rate Hike Risks – Weekend Economic Roundup

New Zealand Faces Stagflation Risk as Iran Conflict Fuels Inflation and Recession Fears

New Zealand’s economic outlook is darkening as the conflict in Iran continues to send shockwaves through global markets, driving up fuel prices and raising the spectre of recession. Treasury is now forecasting a worst-case scenario of 3.7% inflation, while economists warn of a potential return to downturn just months after the country emerged from its last one. The situation is compounded by a lack of appetite for the kind of fiscal and monetary interventions seen during the pandemic, leaving New Zealand particularly vulnerable to external shocks.

The primary driver of concern is oil. Disruptions to the Strait of Hormuz, a critical shipping route for roughly 20% of global oil supply, have pushed global prices above US$100 per barrel. As a near-total fuel importer, New Zealand has little buffer against these price increases, with petrol costs rapidly approaching $4 per litre. Kiwibank chief economist Jarrod Kerr describes the rising fuel costs as “just another cost that they have to wear” for lower-income households already struggling with a prolonged cost-of-living crisis.

The impact is already being felt by consumers, who are postponing large purchases, opting for cheaper alternatives, and reducing travel. This shift in consumer behaviour is translating into tighter budgets and reduced borrowing capacity for households, complicating lending decisions for mortgage advisors. The International Energy Agency (IEA) is urging consumers to work from home and drive slowly to mitigate the impact of rising fuel costs, a stark acknowledgement of the severity of the situation.

The inflationary pressures extend beyond fuel. The conflict is effectively imposing a “giant carbon tax” on the global economy, as American petrol prices have jumped by a third in just four weeks. This surge in prices is expected to translate into sharply higher inflation and lower global economic activity – a classic definition of stagflation. Stagflation presents a particularly difficult challenge for policymakers, as efforts to curb inflation through higher interest rates risk further undermining economic growth and the banking system.

Adding to the economic headwinds, Fitch Ratings has downgraded its outlook for the New Zealand economy from ‘Stable’ to ‘Negative’, citing concerns that meaningful debt reduction is becoming increasingly unlikely for both the private and public sectors. This move reflects a broader concern about the country’s fiscal position and its ability to withstand further economic shocks.

Globally, the situation is further complicated by investor concerns about US fiscal management under the current administration. US Treasury yields jumped to their highest level in nine months last week, as investors begin to anticipate a more hawkish Federal Reserve response to rising inflation. This shift in sentiment is also contributing to a rise in risk premiums and potential downgrades from credit rating agencies.

While domestic data releases are light this week, with February mortgage data and Fonterra results being the key local events, attention will be focused on developments overseas. Australia’s February inflation data, due out on Wednesday, will be closely watched, as will any further escalation of the conflict in the Persian Gulf and its impact on oil and natural gas flows. In the US, a range of sentiment indicators, including PMIs and the University of Michigan consumer survey, will provide further insights into the health of the world’s largest economy.

The situation is volatile and unpredictable. Analysts anticipate a “yo-yo mix of gloom and temporary relief rallies” as markets react to evolving events. The coming weeks will be critical in determining whether New Zealand can navigate these turbulent waters and avoid a return to recession. Investors and consumers alike should brace for continued uncertainty and prepare for a challenging economic environment.

The New Zealand dollar is currently trading at 58.3 US cents, little changed from Saturday, and 83 Australian cents. Gold prices have experienced a significant decline, falling by over 10% in a week to US$4590/oz, marking its largest weekly fall in more than 40 years. Oil prices remain elevated, with American oil at US$98/bbl and Brent crude just over US$112/bbl.