A dramatic fall in interest rates over the past few months will be a game changer for the economy, says Westpac's latest Economic Overview.

"The sharp drop in fixed mortgage rates, combined with the cancellation of capital gains tax, will be a major stimulus for house prices," said Westpac chief economist Dominick Stephens.

"We expect annual house price inflation to accelerate from 1.3 per cent now to 7 per cent over the coming year or so. That should spur consumer spending and remove the need for a further OCR reduction from the Reserve Bank."

In March the Reserve Bank shifted its policy outlook towards reducing the official cash rate - it followed through with a rate cut earlier this month.

The flow through to fixed mortgage rates provides the impetus for an upbeat tone to the latest Westpac research, although it does acknowledge the current slowdown of the domestic economy.


"New Zealand's recent economic performance has been on the disappointing side, Stephens noted.

GDP growth averaged around 0.4 per cent in the last two quarters of 2018, just keeping pace with population growth.

"We're expecting a similarly subdued 0.5 per cent increase in the March quarter," Stephens said. "However we expect momentum to pick up again gradually over the remainder of this year."

Westpac chief economist Dominick Stephens. New Zealand Herald Photograph
Westpac chief economist Dominick Stephens. New Zealand Herald Photograph

Westpac sees annual GDP growth dipping to 2.3 per cent this year before rising back to 3.1 per cent in 2020.

The slowdown was initially led by consumers reacting to the cooling housing market, Stephens said.

"The pace of growth in household spending has accordingly slowed from its peaks,
though it continues to be supported by household income growth via rising employment and wages."

Lately though, the slowdown has become business-led.

"Even though firms are citing capacity constraints and difficulty in finding workers, growth in business investment has been sluggish and private sector job advertisements have flattened off."


Some of that was no doubt due to dissatisfaction with Government policies that have added to business costs, such as minimum wage increases, changes to employment
law, and increased regulatory requirements, Stephens said.

"But an equally important aspect is that firms are not confident about their ability to pass on cost increases. Technology changes and international competition have put more power in the hands of consumers."

Despite that there are a few factors driving Westpac's more upbeat outlook.

The first is that population growth, led by migration, is holding up stronger than expected.

"We've been cautious about factoring this into our forecasts, as under the new methodology the most recent figures can be subject to large revisions. Nevertheless, there is some basis for a more positive view on net migration," Stephens said.

The upgraded outlook for net migration also gives more support to housing construction.

"Growth has been harder to achieve in recent times, now that building activity has reached a relatively high share of GDP and capacity constraints are an issue. Nevertheless, there has been fresh momentum in building consents in recent months, particularly in Auckland which has reached new multi-decade highs."

"Non-residential construction is also expected to lift this year. While this sector tends to experience longer and more variable cycles than housing, interest in commercial
property remains strong and a significant number of projects have been consented or announced."

Finally export earnings are expected to rise this year, "though they will provide less support to GDP growth compared to last year."

"New Zealand's terms of trade have eased back from their highs, but they remain at historically high levels, and we expect prices for our commodity exports to remain robust
this year," Stephens said.