Monetary Policy Statement May 2026

Chapter 1. Summary record of meeting

The ongoing conflict in the Middle East is weakening economic activity and increasing near-term inflation. The Committee remains focused on ensuring that higher costs do not lead to elevated inflation over the medium term, while avoiding unnecessary economic volatility. A prolonged period of weak economic growth and elevated unemployment is expected to dampen medium-term inflationary effects. The Committee judges that the balance of risks is to the upside for inflation and to the downside for growth.

Conflict in the Middle East is disrupting global supply chains

The Middle East conflict has severely disrupted the supply of oil, gas and other petroleum products transiting through the Strait of Hormuz. The decline in oil supply has so far been mitigated through inventory drawdowns, rerouting, increased production elsewhere, and demand adjustment in some countries. This helped contain oil price increases over April and May, despite no resolution to the conflict. Nevertheless, prices for petroleum products have increased substantially since the conflict began, increasing prices for fuel and other petrochemical-intensive inputs such as plastics and fertilisers.

The Committee noted that the outlook for energy prices depends on how the conflict evolves, the extent of damage to energy infrastructure in the Middle East, and the speed with which global supply chains adjust. Members noted that these events will encourage firms to permanently reconfigure their supply chains to reduce exposure to the region. Along with stronger global demand for renewable energy, this may place further upward pressure on global energy prices in the near term.

Pricing in oil futures markets is consistent with a resolution to the conflict over coming months and shipping resuming through the Strait of Hormuz. However, given damage to energy infrastructure and the need to rebuild inventories, oil prices are expected to remain elevated over the medium term.

Trading partner inflation is increasing

The Committee noted that higher energy prices have increased headline inflation in many of New Zealand’s trading partners in recent months. Trading partner inflation is expected to increase further as the direct and indirect effects of higher costs emerge. Members noted that the pass-through of higher costs to near-term inflation will vary across economies, depending on factors such as energy intensity, price controls, subsidies, or tax changes. Differences in current economic conditions, including the degree of capacity pressure, will influence the extent of medium-term inflation pressures across trading partners.

The Middle East conflict poses downside risks to global economic activity. High-frequency indicators suggest that higher petrochemical prices are weighing on sentiment and real incomes in many economies. The impact is expected to be largest for economies with greater reliance on imported energy and energy-intensive manufacturing, including many of New Zealand’s Asian trading partners. In some cases, these headwinds may be partly offset by continued strong demand for artificial intelligence exports and fiscal support.

The New Zealand economy was recovering prior to the conflict

The Committee noted New Zealand was in the early stages of an economic recovery. GDP growth of 0.2 percent in the December 2025 quarter was lower than expected, but timely indicators suggest the economy continued to expand in the March 2026 quarter. For example, strength in retail spending broadened across industries and businesses reported increasing capacity constraints, consistent with the economic recovery gaining momentum.

There has been significant spare capacity in the New Zealand economy for some time. This is reflected in a range of indicators, with the output gap estimated to be -1.3 percent of potential output in the March 2026 quarter, broadly in line with the estimate in February.

The labour market was stabilising, with employment growing modestly and annual wage inflation remaining at 2 percent in the March 2026 quarter. Net migration has increased materially since late 2025. Unemployment remains elevated, indicative of spare capacity in the labour market.

Annual headline inflation remained at 3.1 percent in the March 2026 quarter, which was higher than expected in the February Statement largely due to fuel price increases over March. Underlying inflation has continued to gradually ease, with measures of core inflation declining on average to 2.3 percent.

Near-term inflation is expected to increase, and economic growth to weaken

First-round direct and indirect effects from higher petrochemical prices will increase inflation this year. Direct effects, through higher fuel prices for businesses, are expected to occur slightly faster than the indirect effects of higher prices of petrochemical-intensive inputs. Intelligence from business engagements indicates that some firms have implemented temporary fuel surcharges, although the extent of this varies across sectors. Some businesses are absorbing cost increases into margins given weak demand, while others are embedding higher costs into price changes.

The Committee noted elevated uncertainty around its near-term inflation forecast. The forecast incorporates current oil futures pricing, which assumes Dubai oil prices fall to US$96 per barrel by the end of the year. Annual headline inflation is expected to increase to a peak of 4.3 percent by the September 2026 quarter and to return to the target mid-point in mid-2027. While shorter-term inflation expectations have increased, medium- to longer-term expectations remain close to 2 percent.

Near-term economic activity is likely to be weaker than assumed in the February Statement because of the Middle East conflict. Higher fuel prices are increasing costs, lowering profit margins for many businesses, and reducing real incomes and household purchasing power. High frequency data, including electronic card transactions and measures of business and consumer confidence, are pointing to weak demand in the near term. With weaker consumption and investment, annual GDP growth in 2026 is now expected to be 0.9 percentage points lower than assumed in the February Statement. These forecasts indicate a slower economic recovery in the near term, with the pace of economic growth increasing by the end of the year.

Financial conditions have tightened

Market expectations for central bank policy rates have increased, both domestically and abroad. The Committee discussed how differences in economic starting points, fiscal and structural policy responses to higher fuel prices, and reliance on imported energy will influence the monetary policy response required to contain medium-term inflation across countries.

The Committee noted that financial conditions in New Zealand have tightened through higher wholesale interest rates passing through to higher fixed-term mortgage rates and, to a lesser extent, term deposit rates. The average interest rate on outstanding mortgages declined to 4.9 percent in March but is expected to increase to 5.3 percent over the next 12 months.

Global financial market volatility increased materially in March because of the Middle East conflict but declined following the ceasefire in early April. Global risk appetite has subsequently improved, in part due to strong upward revisions to earnings growth among US technology firms pushing up global equity prices. There has been some volatility in the trade-weighted New Zealand dollar exchange rate, but it is currently little changed since the start of the year.

The Committee was also briefed on financial system stability and agreed this poses no material trade-off to meeting its inflation objective.

The Committee discussed risks to the inflation outlook

Members noted uncertainty around the scale and duration of the global economic consequences of the Middle East conflict and how the shock will propagate through the New Zealand economy and influence medium-term inflation pressures.

The Committee discussed the risk of higher near-term inflation feeding through to medium-term inflation. Members noted that firms’ price-setting behaviour could be more persistent because of generally elevated inflation since the pandemic and the cost-push nature of the current shock. This would lead to stronger second-round inflation effects than currently assumed. This risk is accentuated by low profit margins for some businesses given weak activity and higher costs, limiting the degree to which they can absorb further cost increases. Wage pressures could also arise from labour shortages in some sectors and regions. However, if the recent increase in net migration continues, this would help to offset this risk.

Members noted that spare capacity in the domestic economy and weaker global demand could constrain firms’ ability to pass on higher costs by more than assumed in the central projection. Lower spending by households in response to lower real income growth, persistently elevated unemployment, a weak housing market, and reduced resilience due to repeated shocks collectively pose downside risks to domestic economic activity. However, economic activity could recover faster than assumed if a resolution to the Middle East conflict leads to lower domestic fuel prices.

The Committee discussed risks to the global growth outlook. To the downside, members noted that high and increasing global government debt ratios, alongside greater geopolitical fragmentation, could push up long-term bond yields, tightening financial conditions and weighing on global growth. The Committee also noted that earnings expectations and valuations in US equity markets remain elevated and that if revenues from AI products fail to meet expectations, this could lead to a shock that would pose downside risks to global growth.

To the upside, members agreed that demand for New Zealand’s exports could remain stronger than expected if our Asian trading partners continue to benefit from strong manufacturing investment. Greater investment from large technology firms, alongside stronger investment in economic and military security, may also continue to provide a tailwind to the global economy through stronger economic activity in Asia, Europe and the US.

The Committee noted the three alternative scenarios in the May Statement. These informed the trade-offs influencing the Committee’s discussions and decisions. The scenarios represent just three of many plausible paths for the domestic economy and inflation. In practice, monetary policy decisions depend on a broad range of factors, including prevailing economic conditions, the outlook for medium-term inflation pressure, and the Committee’s secondary objectives of avoiding unnecessary instability in the economy while having regard to financial system stability.

The Committee voted to leave the OCR unchanged at 2.25 percent

The Committee emphasised that it remains focused on ensuring core inflation, wage growth and medium- and long-term inflation expectations remain consistent with inflation at 2 percent over the medium term. It discussed the monetary conditions required to achieve the medium-term inflation mandate. Members noted that financial conditions have tightened materially this year, helping to guard against the risk of second-round price effects.

All Committee members agreed that the central projection for the OCR was appropriate and a good reflection of the trade-offs currently faced. However, members differed in their preferred timing for the initial increase in the OCR.

Three members (Anna Breman, Karen Silk, Paul Conway) judged that holding the OCR at 2.25 percent was appropriate at this meeting. These members emphasised that core inflation and wage growth remain contained and medium- and long-term inflation expectations remain around 2 percent. Indicators of economic activity have deteriorated, in some cases more quickly than anticipated. Tighter financial conditions and economic uncertainty are already weighing on household and business sentiment, which is reducing consumption and investment. Spare capacity in the economy is likely to dampen second-round inflationary pressure.

With inflation pressures increasing in coming months, these members agreed that OCR increases would be required to ensure inflation returns to target over the medium term. These members noted the wide range of estimates for the neutral interest rate, making it difficult to assess the extent to which current monetary conditions are accommodative. They emphasised that the timing of OCR increases should depend on the evolving data, the outlook, and the balance of risks. Close attention needs to be paid to global developments, supply chain normalisation, core inflation, wage dynamics, and inflation expectations. These data, as well high-frequency indicators, will clarify whether stronger second-round inflation effects are emerging.

Three members (Carl Hansen, Hayley Gourley, Prasanna Gai) preferred to increase the OCR by 25 basis points, to 2.5 percent, at this meeting. These members emphasised that, given the breadth of critical inputs that have been impacted by the conflict, first-round indirect price increases could become more broad-based, feeding through to a greater risk of second-round price increases. These members noted that 2-year inflation expectations have risen across a range of surveys. Firms may reset prices based on a shared belief about the persistence of the shock and prices would remain elevated even if the shock were to fade. In addition, should domestic fuel prices decline faster than expected, it may lead to stronger demand as confidence responds more quickly. These members noted that monetary conditions remained accommodative. Further, inflation in New Zealand’s trading partners could increase faster than expected due to both the Middle East conflict constraining supply, and AI-related spending boosting demand.

These members judged that removing stimulus now, while observing domestic economic developments, would help reduce medium-term inflation risks. Moving earlier was viewed as preferable, given upward pressure on neutral rates, and that it may also limit the overall magnitude of the increase in the OCR and the negative impact on output. One member (Carl Hansen) emphasised that raising the OCR at this meeting would also create optionality for further monetary policy tightening in July.

All Committee members agreed that increasing the OCR at upcoming meetings would likely be necessary to ensure higher near-term inflation does not feed through to higher medium-term inflation. The Committee judges that this is a proportionate response to bring inflation to target in a reasonable timeframe without creating unnecessary volatility in output. The pace of OCR increases will depend on the relative influence of persistent wage- and price-setting behaviour versus weaker economic activity on medium-term inflation pressures.

On Wednesday 27 May, three Committee members (Anna Breman, Karen Silk, Paul Conway) voted to leave the OCR on hold and three members (Carl Hansen, Hayley Gourley, Prasanna Gai) voted for a 25-basis point increase. In this instance, the chairperson has a casting vote, meaning the OCR remains on hold at 2.25 percent. The Committee remains focussed on bringing medium-term inflation back to target and expects that OCR increases will be required this year.

Attendees

MPC members: Anna Breman (Chairperson), Carl Hansen, Hayley Gourley, Karen Silk, Paul Conway, Prasanna Gai

Treasury Observer: James Beard

MPC Secretary: Elliot Jones

Chapter 2. Economic assessment and monetary policy outlook

Key points

The Middle East conflict has materially altered the outlook and the balance of risk for inflation and economic growth, globally and in New Zealand. Higher global oil prices have increased domestic inflation directly, through higher prices for petrol, diesel, and other petroleum-based products, and indirectly, through higher input costs faced by businesses. At the same time, higher fuel costs have reduced household disposable incomes. Lower real incomes, elevated uncertainty, and weak confidence are reducing domestic spending and growth.

Inflation was slightly above the Monetary Policy Comittee’s 1 to 3 percent range before the conflict, and is expected to increase in the near term. Annual consumers price index (CPI) inflation remained at 3.1 percent in the year to the March 2026 quarter, in part reflecting higher fuel prices in the month of March. Based on the current outlook for oil prices, CPI inflation is projected to be 4.2 percent in the June 2026 quarter, unchanged from the April monetary policy review, and to peak at 4.3 percent in the September 2026 quarter. This reflects both the direct and indirect first-round effects of the Middle East conflict on New Zealand prices.

Inflation is projected to return to within the target band in the first half of 2027, when the initial increase in fuel prices drops out of the annual calculation. Significant spare capacity in the domestic economy is continuing to dampen underlying inflationary pressure and is expected to limit firms’ ability to pass on higher costs. Measures of core inflation are on average close to 2 percent, and wage growth is at levels consistent with medium-term price stability. While shorter-term inflation expectations have increased, inflation expectations at the five- and ten-year horizons remain close to the 2 percent target mid-point in our survey of business leaders and professional forecasters.

Nevertheless, New Zealand is likely to face additional inflationary pressure as a consequence of recent events in the Middle East. Pricing in futures markets implies that global oil prices are expected to decline over 2026, but to remain around 20 to 30 percent higher than pre-conflict levels in the medium term. Higher inflation in New Zealand’s trading partners and a lower exchange rate are expected to contribute to higher non-oil import prices. Higher near-term inflation is expected to influence price- and wage-setting behaviour in the medium term, despite domestic spare capacity. Monetary policy will respond as needed to ensure that near-term inflation does not feed through to higher medium-term inflation.

The Monetary Policy Committee is focused on ensuring inflation returns to the 2 percent target mid-point over the medium term. Conditional on the central economic outlook, we project that the OCR will need to increase this year. The scale and timing of OCR increases remain uncertain.

Economic assessment

At the start of the year, the New Zealand economy was in the early stages of recovery

Real production GDP increased by 0.2 percent in the December 2025 quarter, following 0.9 percent growth in the September 2025 quarter (figure 2.1).

December quarter growth was weaker than the 0.5 percent growth expected at the time of the February Statement. Growth was supported by continued expansion in services and primary industries, while construction contracted and manufacturing output was broadly unchanged in the quarter.

Timely indicators of activity suggest that the economy continued to grow in the March 2026 quarter, reducing spare capacity (figure 2.2). In the Quarterly Survey of Business Opinion (QSBO), businesses reported an improvement in trading activity and increasing capacity constraints, consistent with the economy gaining momentum and spare capacity being absorbed over the first two months of the year. The Performance of Manufacturing Index (PMI) also improved in the March 2026 quarter, although the Performance of Services Index (PSI) weakened slightly. The Reserve Bank’s GDP nowcasting model, Kiwi-GDP, which incorporates information from these data and a broad range of other indicators, suggests the economy grew 0.5 percent in the March 2026 quarter. ¹

The Middle East conflict has materially altered the economic outlook

The outbreak of the conflict in the Middle East in late February and the subsequent closure of the Strait of Hormuz have disrupted commercial shipping and led to a sharp increase in global prices for oil (figure 2.3). Other petrochemical products, such as plastics and fertilisers, are also directly affected. While oil prices have declined from their peaks in early April, they remain much higher than expected at the time of the February Statement.

Oil futures pricing indicates that financial markets expect the conflict to resolve over the coming months and shipping via the Strait of Hormuz to resume. However, the conflict has caused lasting disruption to oil supply, with damage to production facilities and decreased global inventories. Global strategic oil reserves have been drawn down, and the need to rebuild reserves may support prices for some time after the conflict has resolved. Futures market pricing suggests that oil prices are expected to remain elevated over the projection, around 20 to 30 percent above pre-conflict levels.

The outlook for the Middle East conflict and future oil supply is highly uncertain. Futures markets provide some indication of the expected path of oil prices, but outcomes could diverge materially as the conflict evolves. Measures of economic uncertainty are elevated in New Zealand and internationally, reflecting this risk (figure 2.4). Changes to the outlook for the conflict or differences in how global shocks transmit to the New Zealand economy relative to our assumptions could have material implications for monetary policy (see box A).

Global growth is expected to slow, and global inflation is expected to increase

In response to the conflict in the Middle East, New Zealand’s trading-partner growth outlook has deteriorated since the February Statement (figure 2.5). Growth forecasts for many of New Zealand’s Asian trading partners were revised higher at the start of the year. These upward revisions reflected strong demand for AI-related technology exports as well as less-severe impacts from US tariff policies than initially expected. Since the onset of the Middle East conflict, Consensus forecasts for trading-partner GDP growth have been revised lower for 2026 and 2027.

Trading-partner inflation is forecast to be materially higher than expected at the time of the February Statement. Consensus forecasts for annual trading-partner inflation have been revised from 2 percent in 2026 and 2027 at the time of the February Statement to 2.6 percent and 2.1 percent respectively (figure 2.6). These upward revisions to CPI inflation have been broad-based, although developed markets outside of Asia, such as Australia, the UK, euro area, and the US, have seen the largest increases in their inflation outlook (see chapter 3).

There are downside risks to global growth and upside risks to global inflation. Consensus forecast revisions have been relatively small to date and should be interpreted with caution. Forecasters have made only small adjustments to their central outlook in response to the conflict, while acknowledging the risk of more severe outcomes. Our central projection for GDP growth in New Zealand’s trading partners is lower than Consensus expectations, and our central projection for trading-partner inflation is higher (see chapter 5).

Financial conditions have tightened

Interest rates have increased in advanced economies. Market expectations for policy rates have shifted materially higher in the US, Australia, and other advanced economies. Central banks have communicated a willingness to look through the direct inflationary effects of the Middle East conflict, but remain alert to more persistent or generalised inflationary pressure. Higher policy rate expectations have led to increases in government bond yields, particularly at shorter maturities.

Wholesale interest rates in New Zealand have also increased, reflecting higher expected policy rates in the near term and the rise in global bond yields at longer horizons. Some of the increase in market-implied OCR expectations may reflect illiquidity in wholesale interest rate markets since the onset of the Middle East conflict. Market pricing for the OCR has shifted about 75 basis points higher, to around 3.5 percent by the end of 2026. Retail lending and deposit rates have also increased, albeit to a lesser extent (see chapter 3).

New Zealand is facing less favourable terms of trade

Higher fuel and non-fuel import prices are weighing on New Zealand’s terms of trade (figure 2.7). In addition to higher fuel costs, New Zealand businesses are facing higher prices for fertiliser, petrochemicals, and petrochemical-derived products such as plastics. More generally, higher inflation in New Zealand’s trading partners is expected to contribute to higher prices for a wide range of imported goods and services. The New Zealand dollar has depreciated on a trade-weighted basis since the February Statement, reflecting weaker risk sentiment in response to the Middle East conflict. If sustained, this will also contribute to higher import prices in New Zealand dollar terms.

Prices for some of New Zealand’s commodity exports have been elevated, but are expected to fall as global demand slows. High global commodity prices for meat, dairy, and aluminium have supported New Zealand exporter incomes. Over the coming seasons, high fertiliser prices may provide further support to dairy and meat prices, while a weaker New Zealand dollar helps sustain New Zealand dollar incomes. However, weaker global demand is expected to outweigh these factors and weigh on export prices over the medium term.

The conflict will have wide-ranging impacts on inflation and growth in New Zealand

The Middle East conflict will affect inflationary pressure in New Zealand through a range of trade, financial market, and uncertainty channels. To better explain our assumptions about the implications of the conflict for inflation in New Zealand, we classify the effects into four broad categories:

• First-round direct effects describe the immediate impact of changes in global
  oil prices on petrol and diesel prices in
  the CPI.
• First-round indirect effects describe changes in the prices of other goods and services in the CPI that use directly affected goods as inputs.
• Second-round demand effects describe how reduced household and business spending increases spare capacity, dampening inflationary pressure.
• Second-round price effects describe the way in which higher prices in the near term propagate through the economy over the medium term via price- and wage-setting behaviour. Second-round price effects also include the medium-term impact of generalised global inflationary pressure and a weaker New Zealand dollar on import costs and domestic prices.

The effect of the Middle East conflict on medium-term inflationary pressure will depend on the balance between inflationary second-round price effects and disinflationary second-round demand effects.

First-round direct and indirect effects will contribute to higher inflation in 2026

The Middle East conflict will result in materially higher near-term CPI inflation in New Zealand. Higher global oil prices have increased inflation in New Zealand directly, through higher prices for petrol, diesel, and other petroleum-based products, and indirectly, through higher input costs faced by businesses (figure 2.8). Annual headline inflation was 3.1 percent in the March quarter and is projected to increase to 4.3 percent in the September 2026 quarter, based on current oil futures market pricing. Annual headline inflation would have been 3.0 percent in the March 2026 quarter, if the January 2025 increase in vehicle licensing fees had been correctly captured in the March 2025 quarter CPI release. ²

Tradables inflation is projected to increase in the near term. Annual tradables inflation decreased slightly to 2.5 percent in the March 2026 quarter, but was higher than forecast in the February Statement. Higher-than-expected tradables inflation in the March 2026 quarter can largely be attributed to the direct effect of higher petrol and diesel prices in the month of March. Annual tradables inflation is projected to increase to 5.6 percent in both the June and September 2026 quarters, reflecting higher quarterly average fuel prices and significant indirect effects on other prices, particularly food and international travel.

Non-tradables inflation is also expected to be impacted by the Middle East conflict, though to a lesser extent. Annual non-tradables inflation remained stable at 3.5 percent in the March 2026 quarter, slightly higher than the February Statement projection. Elevated non-tradables inflation prior to the conflict mostly reflects high administered price and energy inflation.³ The Middle East conflict likely had negligible impact on non-tradables inflation in the March 2026 quarter. Whereas fuel prices tend to adjust very rapidly in response to a change in oil prices, other prices generally respond with some delay. We expect indirect effects of the conflict to begin contributing to non-tradables inflation from the June 2026 quarter. Annual non-tradables inflation is expected to remain around 3.5 percent over 2026, as the indirect effect of higher fuel prices on items including domestic airfares, other transport, and construction are offset by declining inflation in other non-tradable components.

Second-round demand effects will dampen economic growth

Household consumption is expected to remain subdued in 2026, as higher fuel prices reduce real disposable incomes and weigh on household confidence. Some households may maintain spending on other goods and services despite higher fuel prices by drawing on savings. However, higher mortgage rates may limit households’ willingness to take on new lending, and uncertainty about the labour market may lead to more cautious behaviour. Many households will respond to higher living costs and uncertainty by reducing their spending on non-essential goods and services. While evidence from the Retail Trade Survey suggests that consumption was recovering in the March 2026 quarter, both electronic card transaction data and recent business engagements indicate that demand for non-essential goods is slowing (see box B).

Businesses are expected to delay investment, reflecting heightened uncertainty, weaker demand, and compressed margins. Many firms are reporting that they have been unable to pass on the full extent of input cost increases to selling prices, impacting profitability. Reduced margins, lower consumer demand, and heightened uncertainty about the economic outlook may lead firms to delay or scale back investment, despite recently strong export revenues. Over the medium term, investment is projected to recover as activity strengthens and uncertainty eases.

The expected recovery in residential investment may be delayed. The Middle East conflict has increased the cost of construction via higher prices for diesel and materials. High uncertainty and increasing mortgage rates are expected to dampen house price growth, reducing the incentive to build new houses.

The near-term growth outlook is weaker than previously assumed. Taken together, weaker consumption and investment mean that annual GDP growth is expected to be 0.9 percentage points lower in the year to the December 2026 quarter relative to the February Statement.

Spare capacity will persist for longer

There is significant spare capacity in the domestic economy. Before the onset of the Middle East conflict, a range of indicators suggest that spare capacity was being gradually absorbed (see chapter 4.2). In the February Statement, we projected that a gradual recovery in demand, supported by low interest rates, would continue to reduce spare capacity. However, the Middle East conflict is expected to materially delay the economic recovery, and spare capacity is projected to persist. The output gap is estimated to be around -1.5 percent of potential output in the June 2026 quarter, and is expected to remain at or below that level for another year (figure 2.10). The output gap is projected to recover in the latter half of the projection as inflation falls, real income growth recovers, and uncertainty fades.

New Zealand’s supply capacity is growing slowly. Low investment, slow population growth, and weak productivity growth have all contributed to low potential output growth in recent years. This constrains the rate at which the economy can grow without contributing to inflationary pressure. However, net immigration has increased materially since late 2025, which will increase the labour force and contribute to higher potential growth if sustained.

Spare capacity in the labour market is projected to persist. Recently, labour market conditions have shown signs of stabilising. The unemployment rate decreased to 5.3 percent in the March 2026 quarter (figure 2.11). Employment grew modestly, while labour force participation declined. Total hours worked grew strongly for the third consecutive quarter. Most measures of labour market tightness remain at levels consistent with substantial spare capacity (figure 2.12).

Elevated unemployment is projected to persist for longer than assumed in the February Statement. Low profitability, spare capacity, and heightened uncertainty about the outlook will make businesses cautious about taking on new workers. Meanwhile, recovering migration flows are adding to population and the labour force.

All measures of core inflation that we regularly monitor are within the MPC’s target range for headline inflation. Of the five measures we monitor, four decreased in the March 2026 quarter, while one increased. On average, these measures indicate that annual core inflation was about 2.3 percent (figure 2.14).

There may be some spillover from temporarily higher headline inflation to core inflation. Oil-derived products are an important input into the production of many goods and services, and cost pressures are emerging across a wide range of products. However, substantial spare capacity is expected to materially constrain the extent of any increase. Core inflation is expected to remain within the MPC’s 1 to 3 percent target range for CPI inflation, with headline inflation converging towards core inflation in the latter half of the projection as the first-round effects of the Middle East conflict on inflation dissipate.

Expectations for inflation one year ahead have increased materially in the June 2026 quarter across households, businesses, and professional forecasters (figures 2.15, 2.16, and 2.17). These increases are consistent with a large salient price shock and are of a magnitude that is consistent with our June 2026 quarter forecast for CPI inflation, assuming the typical relationship between actual and expected inflation (see chapter 4.2 of the August 2025 Statement).

Longer-term inflation expectations of businesses and professional forecasters have been stable or declining, while household inflation expectations increased. Five-year ahead inflation expectations of households increased in the latest quarter. Five- and ten-year ahead inflation expectations of professional forecasters and business leaders in the Survey of Expectations (SOE) declined slightly in the June 2026 quarter, and are close to the 2 percent target mid-point for inflation. In 2024, the Reserve Bank of New Zealand introduced the Tara-ā-Umanga – Business Expectations Survey, which covers a much larger and more representative sample of New Zealand businesses than the SOE. It suggests that longer-horizon inflation expectations are declining. However, the relatively short history of these data limits interpretability.

Inflation is projected to return to near the target mid-point in 2027

Annual CPI inflation will fall when the initial increase in fuel prices drops out of the annual calculation. Retail petrol and diesel prices are projected to continue to decline across the remainder of the year, in line with futures market pricing. If petrol and diesel prices decline as expected, annual tradables inflation will decline quickly. Even if fuel prices were to remain around current high levels, annual inflation will fall once the June 2026 quarter increase drops out of the calculation.

Headline inflation is projected to return to the 2 percent target mid-point next year. Significant spare capacity will continue to limit the extent to which costs can be passed on to prices and limit wage growth, supporting a gradual decline in non-tradables inflation. Tradables inflation is assumed to return to around historical average rates once fuel price increases drop out of the annual calculation. Monetary policy will respond as required to offset any additional medium-term inflationary pressures and ensure that inflation settles sustainably near the 2 percent target mid-point in the medium term.

Monetary policy outlook

Conditional on the central economic outlook, we project that the OCR will increase this year to ensure that inflation settles sustainably near the 2 percent target mid-point in the medium term (figure 2.19).

Compared to the February Statement, the OCR is projected to increase sooner and by more. This reflects higher medium-term inflationary pressure arising from the Middle East conflict. The near-term increase in inflation due to higher fuel prices is assumed to be temporary, and to partially reverse over the projection. However, we assume that there will be smaller but more persistent second-round effects on medium-term inflationary pressure. The pace of OCR increases will depend on the relative influence of persistent wage- and price-setting behaviour versus weaker economic activity on medium-term inflation pressures.

Chapter 3. Global economy and financial markets

Key points

Before the Middle East conflict, global growth had been stronger than previously assumed. New Zealand’s trading-partner growth rose by more than expected at the February Statement, reaching 3.2 percent in the year to the March 2026 quarter, as growth in Asia was buoyed by AI-related export demand.

Inflation has continued to increase in trading-partner economies. Annual trading-partner CPI inflation rose to 2.2 percent in the March 2026 quarter, continuing its upwards trend since the June 2025 quarter.

The Middle East conflict presents downside risks to global activity and upside risks to inflation. New Zealand’s Asian trading partners are particularly exposed to higher imported energy costs. This exposure is partly offset by fiscal support, large oil reserves, and regulated or subsidised retail energy prices. The region also continues to benefit from AI-related export demand. Compared to the February Statement, our central projection assumes that trading-partner growth is 0.2 percentage points lower on average over 2026, while trading-partner inflation is 0.7 percentage points higher over the same period.

Higher expected inflation has led to expectations for tighter monetary policy in many advanced economies. Government bond yields have increased materially across all maturities, and most sharply at shorter maturities.

Energy prices are elevated and are expected to remain higher than previously anticipated over the medium term. Crude oil prices are 45 to 60 percent higher than at the time of the February Statement, while refined fuels like diesel, petrol, and jet fuel have increased in price even more. Futures markets imply that crude oil prices are expected to decline over time, but remain
20 to 30 percent higher over the medium term compared to before the outbreak of conflict in the Middle East. European and Asian natural gas prices have increased by 60 to 90 percent.

Domestic financial conditions have tightened since the February Statement due to higher interest rates as a result of the Middle East conflict. The 2-year swap rate has increased by around 50 basis points to 3.6 percent since the February Statement. Wholesale and retail rates have increased, with wholesale rates increasing by more than retail rates. The average yield on total mortgage lending is likely to increase this year, tightening financial conditions via the cashflow channel.

Global economic conditions

Before the Middle East conflict, global growth had been resilient and inflation was increasing

Growth among New Zealand’s trading partners was stronger than expected at the start of 2026. Global economic activity was resilient to headwinds from higher US tariff policies and elevated uncertainty over 2025 and the March 2026 quarter. Annual trading-partner growth is estimated to have been 3.2 percent in the year to the March 2026 quarter (figure 3.1). Growth amongst our developed Asian trading partners was stronger than anticipated at the time of the February Statement, with the region benefiting from increased export demand for AI-related technology products. Additionally, in Australia and the US, AI-related investment, resilient household consumption, and accommodative fiscal policy have supported economic activity in the March 2026 quarter.

Trading-partner inflation was already increasing before the Middle East conflict. Annual trading-partner CPI inflation increased from 1.6 percent in the June 2025 quarter to 2.2 percent in the March 2026 quarter (figure 3.2). There has been a range of drivers for this increase in inflation in some of our major trading partners. In the US, the pass-through of tariffs into consumer prices has put upwards pressure on inflation, though is estimated to have largely run its course. Australia is facing domestic capacity pressures, a relatively tight labour market, and robust GDP growth aided by strong business investment. In China, annual inflation averaged 0.8 percent over the March 2026 quarter, up from an average of 0 percent in 2025. This was largely due to higher food prices and seasonality around the timing of the Lunar New Year.

The Middle East conflict presents downside risks to global activity and upside risks to inflation

High-frequency indicators point to a deterioration in global growth and confidence since the start of the Middle East conflict. Global purchasing managers’ indices (PMIs) suggest firms are facing higher input prices and longer delivery times. Reported activity growth in the services sector has declined in many economies. Manufacturing activity has been less affected, reflecting continued demand for AI-related goods. Consumer and business confidence has also weakened in recent months, with most measures below their historical averages.

The outlook for the global economy remains highly uncertain. New Zealand’s Asian trading partners are particularly exposed to higher imported energy costs. In many cases fiscal support, large oil reserves, and regulated or subsidised retail energy prices should help dampen the immediate impact on households and firms. The region also continues to benefit from AI-related export demand, which does not appear to have been materially affected by the economic effects of the Middle East conflict. Among New Zealand’s other major trading partners, the US, Australia, and Canada are net energy exporters, reducing the downside activity effects of the shock relative to more energy-import-dependent economies.

Our central projection assumes that trading-partner growth is 0.3 percentage points lower on average over 2026 and 2027, while trading-partner inflation is 0.7 percentage points higher over the same period. To inform our assumptions, we have assessed a range of estimates from Bloomberg consensus forecasts, the International Monetary Fund, and a variety of internal modelling approaches (see chapter 5). Our central projection assumes that in 2026, trading-partner growth is 2.6 percent while inflation is 2.7 percent. Growth is assumed to improve slightly to 2.7 percent in 2027, while inflation remains elevated at 2.7 percent. These projections are subject to considerable uncertainty, and there remains a wide range of possible outcomes for the conflict in the Middle East and associated macroeconomic impacts.

Energy prices are elevated, but futures pricing indicates that market participants expect prices to decline

Energy commodity prices have increased significantly since the February Statement. Crude oil prices are 50 to 60 percent higher across the major international benchmarks, while natural gas prices in Asia and Europe have increased by 60 to 90 percent. New Zealand does not import natural gas and is therefore not directly exposed to this price increase, but many of our trading partners in Europe and Asia will be affected.

Dubai crude oil, the most relevant benchmark for New Zealand and many of its trading partners, initially rose more than other benchmarks due to concerns of acute supply disruptions in the Middle East. However, the price of Dubai crude has moved closer to other oil benchmarks as supply has been redirected from other regions and global inventories have been drawn down. Adjusted for inflation, Dubai crude oil prices remain below peaks reached during previous periods of elevated energy prices but are high relative to historical levels (figure 3.3).

Refined fuel prices have increased by more than crude oil prices. Prices for refined products, including diesel, petrol, and jet fuel, have increased more sharply than crude oil prices, due to reduced refinery capacity in the Middle East and lower refined fuel output globally. After rising about 120 percent early in the conflict, Singapore refined fuel prices are currently about 60 percent higher than before the conflict (figure 3.4).

Futures prices imply material declines in energy prices over the coming months, though prices over the medium term are higher than at the time of the February Statement. Oil and gas futures imply a 20 to 30 percent decline from current prices in the next twelve months, with the majority of this occurring within the next six to ten months. However, longer-dated futures contracts imply that energy prices are expected to be around 20 to 40 percent higher on average over 2027 relative to the conflict.

The Middle East conflict has increased prices of many non-energy commodities

Around a quarter to a third of globally traded nitrogenous fertiliser is exported via the Strait of Hormuz. Disrupted supply has led to a large spike in fertiliser prices, with urea rising 80 percent and diammonium phosphate rising 16 percent from February to April. China and Russia have also restricted fertiliser exports, further tightening supply conditions. Food prices have increased slightly since the onset of the conflict, but broader increases may emerge if fertiliser supply remains compromised during periods of seasonally higher demand in Asia over the June to August period and later in the year.

The Middle East also supplies a large portion of global plastic feedstock, helium, and sulphur, which are crucial inputs into a range of industrial processes. Higher prices for these input goods could put upward pressure on goods prices and compress producer profit margins in New Zealand and trading-partner economies.

Global financial conditions

Interest rates have increased globally since the February Statement

Financial market participants expect that monetary policy over the next year will be tighter across most advanced economies than at the time of the February Statement. Market-implied expectations for policy rates in developed markets at the end of 2026 have increased by 40 to 120 basis points since the beginning of the Middle East conflict (figure 3.5). Central banks have generally communicated a willingness to look through the first-round effects of the energy price shock but remain alert to second-round effects, including the risk of higher inflation expectations and pass-through into wage inflation. Most advanced economy central banks left policy settings unchanged at their most recent meetings. The Reserve Bank of Australia opted to tighten monetary policy further at its May meeting, having also increased its cash rate at the previous two meetings in response to emerging domestic capacity pressures.

Government bond yields are higher. The largest increases have been at the 2-year tenor, consistent with expectations for tighter monetary policy over the next year. Smaller increases in 5- and 10-year yields largely reflect market expectations for higher inflation over the medium term and central banks maintaining tighter policy settings in response (figure 3.6).

Global risk appetite has remained relatively strong despite the Middle East conflict

Exchange rate movements have mainly reflected differences in exposure to the energy shock and changes in expected monetary policy settings. Among New Zealand’s trading partners, currencies of net energy exporters and those expected to tighten monetary policy by relatively more have broadly appreciated. The currencies of countries more reliant on imported energy, and therefore more exposed to downside activity effects of this shock, have in general seen larger depreciations (figure 3.7). The US dollar had appreciated by as much as 3 percent on a trade-weighted basis since the February Statement, supported by demand for oil priced in US dollars, the US’ status as a net energy exporter, and safe haven flows. As risk sentiment has improved, the US dollar has weakened slightly, currently sitting around 2.1 percent higher than at the time of the February Statement.

Global equity markets have been supported by strong earnings growth. At the onset of the conflict, equity prices fell by around 10 to 15 percent, troughing near the end of March. However, equity prices recovered over April and are now above their pre-conflict levels in many economies (figure 3.8). This recovery has been underpinned by strong earnings growth, particularly in the technology sector, as demand for AI-related tech products continues to grow. Energy firms have also benefited from higher commodity prices.

Domestic financial conditions

Wholesale interest rates have increased

Domestic financial conditions have tightened due to higher interest rates as a result of the Middle East conflict. New Zealand swap rates have increased by around 30 to 50 basis points since the February Statement, with the largest increases at shorter tenors (figure 3.9). This reflects market expectations for higher inflation over the near term and a faster and larger increase in the OCR in response (figure 3.10). Since the February Statement, market pricing for the level of the OCR by the end of 2026 has increased by around 60 basis points to 3.5 percent.

Lending and deposit rates have increased

Since the February Statement, retail rates have increased, but less so than wholesale rates. Most term deposit rates have increased between 20 and 40 basis points (figure 3.11). The popular 6-month term deposit rate has remained unchanged. Similarly, mortgage rates for terms of 6 months to 5 years have increased between 5 and 40 basis points (figure 3.12).