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The economy is expected to improve sooner rather than later, though the path may be far from smooth as an upturn in geopolitical risks increase market volatility.
"Households, businesses and financial markets need to keep an open mind about how the economy will play out over coming quarters," Westpac chief economist Kelly Eckhold said, adding that significant uncertainties continued to cloud the economic outlook.
"The upcoming US elections could have implications for the economic outlook, interest rates and the exchange rate. More generally, geopolitical risks remain elevated."
The latest Westpac Economic Overview suggested inflation was comfortably back in the Reserve Bank's target band of 1 to 3 percent.
Given the inflation outlook, Eckhold said monetary policy settings were expected to move back towards a neutral stance, which could see the official cash rate (OCR) drop to a low point of perhaps 3.5 percent, from the current rate of 4.75 percent.
However, he said easing monetary policy would take a while to drive up productivity with the economy constrained by slower population growth, with net migrant inflows likely to fall temporarily towards zero in 2025.
Households and businesses
Eckhold said conditions for the retail and hospitality sectors were expected to remain tough, with concerns about job security likely to weigh on discretionary spending for a while yet.
"Businesses continue to report tough trading conditions, including pressure on margins. In the near term, we expect a further modest reduction in businesses' investment spending as firms respond to these pressures."
He said a drop in interest rates would eventually flow through to mortgage interest rates over the next year, which should also drive up the price of houses by 8 percent next year and a further 5 percent in 2026.
"The housing market underperformed our expectations over the past year, with prices moving sideways amidst low sales and plentiful listings.
"However, with mortgage rates now declining, indicators point to a lift in buyer interest, and we expect confidence will return to the market.
"That strengthening in the housing market should also support a recovery in residential construction activity from the second half of next year."
Photo: RNZ / Quin Tauetau
Unemployment forecast to rise
Eckhold said the labour market was expected to remain weak for at least the next six months, with unemployment estimated to have risen to 5 percent in the three months ended September, and peaking at 5.5 percent by the middle of 2025.
"Thereafter, growth in activity should be sufficient to at first stabilise the unemployment rate, followed by a downtrend in 2026 as the recovery strengthens," he said.
But in the near term, he said weak labour market conditions would weigh on consumer sentiment.
External and primary sector outlook
Elsewhere, Eckhold said the prospects for the primary sector would be constrained by weak demand, though commodity prices were expected to improve in 2025.
"This will be a boon to rural communities, in particular."
Still, government spending would continue to be a challenge, with a plan to return the Treasury's books to surplus.
"Our forecasts imply a slightly lower tax take than projected in Budget 2024.
"Combined with upward pressures on spending that may prove difficult to contain, we think a return to surplus is more likely in 2028/29 - a year later than the Treasury is forecasting at present."
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