In both July and September this year when the Reserve Bank reviewed the state of the economy and monetary policy, they raised the official cash rate by 0.25%. That means it now stands at 2.75% from the 2.25% low it was taken to late last year.

The Reserve Bank is raising interest rates because inflation at 4.1% – even allowing for about 0.8% from higher oil prices – is running above the 1% – 3% target range. But they have also been pressured to raise rates because in hindsight they cut the cash rate by 0.75% too much late last year when the state of the economy did not warrant it.

Our economy grew by 0.9% in the September quarter of 2025 then 0.5% in the December quarter and again 0.9% in the March quarter of this year. But the cash rate was cut 0.75% over October and November in order to stimulate growth.

So far, perhaps because of the long list of uncertain factors making businesses wary of raising prices, the extra stimulus to inflation from the late-2025 rate cuts looks minimal. But we are still left with a situation where growth in the economy is lifting, inflation is above average, and the unemployment rate is set to soon start falling and placing upward pressure on labour costs.

In this environment the Reserve Bank are predicting inflation will fall to 2.1% by the end of 2027. That is a big gamble. In fact, the situation is a bit more challenging than this suggests.

For many items which go into the calculation of our inflation rate there is upward pressure. A big one is the AI boom. This has caused a sharp lift in prices for computer chips and most of the electronic goods we buy these days include chips. Given that falling prices for electronic goods have been a key source of downward pressure on NZ inflation for the past couple of decades there are risks for our cost of living now in play.

The AI boom will also tend to place upward pressure on electricity prices though by how much is impossible to calculate. El Nino weather conditions this year risk production of many of our farm products and that will tend to push food prices higher.

The war between Russia and Ukraine is also tending to push up food prices – including for red meat – especially now that Ukraine is increasingly targeting the grain industry in Russia. Much red meat produced outside New Zealand is grain-fed.

Our local councils are facing a future where their rates rises will largely be capped at 4%. But that rule won’t start until 2029 so there is a risk they push through the biggest rates rises they can in the next two years to minimise funding pain down the track.

Climate change is adding to our costs in various ways, and import prices generally are moving upward because of the Kiwi dollar’s weakness against the US and Australian currencies.

Finally, there is the big factor I have been highlighting for some time of crunched business margins and evidence from businesses that once customer flows are much stronger, they will raise prices in order to restore profitability. Currently most do not feel in a strong enough position to do so. That will likely change over 2027 and 2028. At this stage there is little justification for thinking the Reserve Bank will again need to throw the economy into recession in order to control inflation. But upside risks to interest rates exist and while this will not be welcomed by borrowers, for savers and investors the recent period of unusually low interest rates may be coming to an end as we advance through 2027 in particular.

This article has been provided for general information only. Tony Alexander is an independent economist and produces a free weekly publication with a housing focus called "Tony's View". You can sign up at www.tonyalexander.nz