A divide has opened up across the Tasman Sea and Pacific Ocean, as New Zealand cuts interest rates and the US prepares to follow, while Australia’s Reserve Bank waits for stronger signs prices have cooled.

Australians are enduring the highest interest rates in more than a decade, with mortgage relief unlikely until next year amid stubborn inflation in key sectors, such as rents and utility bills.

Home owners in neighbouring NZ, meanwhile, are enjoying relief on monthly mortgage repayments already.

In the US Federal Reserve chair Jerome Powell is also signalling interest rate cuts are imminent as inflation falls across North America.

That cut, which will end an extended rate pause in the US, is tipped for next month when the Fed meets on September 17-18.

Different strategies

Westpac economists say the “diverging trends” between Australia and NZ reflect differences in how central bankers have dealt with high inflation since Covid-19.

Rates peaked higher in NZ and have begun falling faster after inflation eased significantly.

“Inflation on both sides of the Tasman is dropping back, but the downtrend in core inflation measures in New Zealand looks more pronounced,” Westpac economists said on Tuesday.

Central bankers use interest rates to influence demand for goods and services; when rates are hiked businesses find selling harder, which limits their ability to raise prices without losing profits.

And so when NZ raised its cash rate 1.75 per cent above its long-run neutral level in 2023, it sparked a sharp decline in demand that Westpac predicts will end with a recession.

“[New Zealand’s] GDP has fallen 0.5 per cent over the past 18 months,” they said.

“We estimate that activity contracted a further 0.6 per cent in the June quarter, with a 0.2 per cent fall expected in the September quarter.”

Unemployment has also spiked as businesses stop expanding and even collapse, which has also meant lower wages growth than in Australia because workers are easier for bosses to find.

Interest rates also rose higher in the US than Australia post-Covid, which also sparked an increase in unemployment.

But inflation across the US has also fallen faster than in Australia, down from 3.48 per cent in March to 2.89 per cent over July.

That has opened the door for the fed to start rate cuts as soon as September.

In contrast, Australia’s Reserve Bank is tolerating higher inflation for longer and holding rates at 4.35 per cent, only 0.85 percentage points above the long-run neutral level, Westpac said.

RBA governor Michele Bullock has described the plan as “walking a narrow path” in an attempt to ensure employment growth continues, with unemployment forecast to peak at 4.6 per cent.

That’s only slightly above the trend rate, while NZ is expected to see unemployment rise to 5.6 per cent over the year ahead, which is well above their long-term trend of 4.5 per cent.

Varied risks

Each strategy comes with its own set of risks, and ultimately each economy has key differences that have pushed central bankers down their own paths in the years since the Covid pandemic.

NZ has had price growth ease markedly faster, but is set to suffer a recession.

The US has managed to avoid an economic downturn and position itself to begin rate cuts sooner, though unemployment has risen.

Australia has so far avoided a broad economic downturn, though has experienced one when production is adjusted for population growth, but faces its own risks tolerating higher inflation.

Economists have said that by accepting that inflation will remain above the 2 to 3 per cent target band until late 2025, Australia risks a much more painful correction if expectations shift.

In other words, consumers and businesses may become used to and begin to anticipate current levels of price growth when they make decisions about setting wages or purchasing groceries.

Baking in that higher level of inflation into the economy could make it much harder for the RBA to bring price growth back into the target band and even spark an additional round of rate hikes.

The RBA has its eyes on inflation expectations, but experts have warned that they’re often hard to measure in real time and can leave central bankers in reaction mode if they do start to shift.