Taking Stock - 17 September 2026

Last week we wrote about the Reserve Bank’s decision to increase the Official Cash Rate to 2.75%. We also warned that the period of falling interest rates may have ended earlier than many households had hoped.

The case for another increase has strengthened since then. 

Oil remains above US$100 a barrel, the US Federal Reserve has increased interest rates, government bond yields are around 5% in New Zealand and the United States, and New Zealand’s economy has performed better than the Reserve Bank expected.

The next OCR decision is on 28 October. Another increase from 2.75% to 3.00% now looks more likely than it did a week ago. 

New Zealand is particularly exposed to higher oil prices because we import almost all the refined fuel we use. When international oil and refining costs rise, the effects quickly reach petrol stations, transport companies, airlines, farmers and other businesses.

Fuel was the main reason annual inflation increased to 4.1% in the June quarter. Vehicle fuels contributed around 1.2 percentage points to that figure. Excluding fuel, annual inflation was 2.9%.

The Reserve Bank assumes that oil prices will gradually ease. If that happens, the contribution from petrol and diesel will eventually fall out of the annual inflation figures. This would help inflation return to the Bank’s 1 - 3% target range next year.

However, Brent crude remains above US$105 a barrel. Oil fell during the latest trading session, but prices are still much higher than they were before the conflict in the Middle East intensified.

The Reserve Bank is concerned about more than the price displayed at the petrol station. It is watching to see whether higher fuel costs begin spreading into the prices of other goods and services.

Many businesses initially absorbed part of the increase. Household spending was weak, and companies knew another price rise could cost them customers. A trucking company could accept a lower margin, a food producer could absorb more expensive transport and packaging, and a retailer could avoid increasing prices despite paying more for freight.

This can only continue for so long. If fuel remains expensive, businesses will eventually pass more of the cost on to customers. Some may also try to recover part of the margin they gave up earlier.

The Reserve Bank expects the effects to become more visible in food, road transport, construction, plastics, fertiliser and air travel. These increases would keep inflation higher even if petrol prices stopped rising.

Air New Zealand provides a useful example. Jet fuel is one of its largest operating expenses, and the airline expects its fuel bill to increase significantly during the second half of its financial year. It has already increased some fares and reduced capacity on parts of its network.

The airline cannot simply add every dollar of extra fuel cost to ticket prices. It competes with Qantas, Jetstar and numerous international carriers. Large fare increases could reduce demand or encourage travellers to use another airline.

Air New Zealand must therefore absorb part of the increase, charge passengers more, reduce flights or cut spending elsewhere. It is likely to use a combination of these options.

The consequences extend beyond Air New Zealand shareholders. Higher airfares affect tourism, business travel and families visiting relatives. Fewer flights can reduce regional and international connections, while cost reductions may affect employment, suppliers and future investment.

Thousands of businesses are making similar decisions on a smaller scale. The longer oil stays above US$100, the more difficult it becomes for them to protect customers from the increase.

New Zealand’s latest overseas accounts already show the cost. During the June quarter, the country spent $1.5 billion more importing goods than it earned from exporting them. Higher prices for diesel, petrol and jet fuel were a major contributor.

This means New Zealand is sending more money offshore to pay for fuel before the full effect has reached domestic prices. It leaves less income available to households and businesses.

The June-quarter GDP figures added to the likelihood of an October OCR increase. The economy grew by 0.2%, while the Reserve Bank had expected no growth. Growth for the previous quarter was also revised slightly higher.

The economy expanded by 2.6% compared with the June quarter last year. This was stronger than the 2.1% expected by the Reserve Bank and the 2.2% expected by ANZ and the wider market.

This does not mean the economy is booming. The recovery remains uneven. Construction, manufacturing, exports and several service industries grew, but household spending was flat. Accommodation, food services and transport went backwards.

Many households are still dealing with higher living costs, weak house prices and an uncertain employment market. The economy is recovering, but the improvement has not reached everyone.

The stronger GDP figures still give the Reserve Bank less reason to wait. The economy avoided contraction, oil prices have risen, and the New Zealand dollar has been weaker than the Bank expected.

A weaker New Zealand dollar increases the local cost of imported fuel and other goods. Even if the international price remains unchanged, New Zealand businesses may have to pay more once the cost is converted into our currency.

The Federal Reserve’s decision adds to the pressure. It increased its main interest rate by 0.25 percentage points last night. This was its first increase in more than three years, and most Federal Reserve officials expect at least one more increase before the end of 2026.

The United States is dealing with inflation that has remained higher than expected and an economy that continues to grow. Its central bank is now signalling that interest rates could remain high for longer.

At its September meeting, the Reserve Bank appeared to be leaning towards leaving the OCR unchanged in October. Developments since then have shifted the balance. ANZ now expects an increase in October rather than December too.

There is still important information to come. New Zealand’s next inflation figures will be released on 22 October, six days before the OCR decision. A weak inflation result or a sharp fall in oil prices could still give the Bank room to wait.

There is an uncomfortable irony in using interest rates to respond to an oil shock. Increasing mortgage payments cannot lower the price of oil or reopen an international shipping route. Higher interest rates work by reducing spending elsewhere in the economy, making it harder for businesses to increase prices.

This is difficult for households already facing higher petrol, food and electricity bills. Some mortgage borrowers may now face higher living costs and another increase in their loan repayments at the same time.

The 10-year government bond yield is now around 5% in both New Zealand and the United States. Put simply, this is the return investors expect for lending money to a government for 10 years.

Government bond yields help set borrowing costs across the wider economy. If the New Zealand Government must pay around 5%, companies generally need to offer investors a higher return because lending to a company carries more risk. Higher bond yields can also increase bank funding costs, which may flow through to business loans and fixed mortgage rates.

Governments eventually pay these higher rates as existing debt matures and is replaced with new borrowing. The United States provides an extreme example of how quickly the figures can become uncomfortable.

US government debt has now passed US$40 trillion. If the average interest rate paid on that debt eventually increased by one percentage point, annual interest costs would rise by US$400 billion.

At the current exchange rate, US$400 billion is about NZ$700 billion. New Zealand’s entire government tax revenue for the 2025/26 financial year was forecast at approximately NZ$125 billion.

The additional US interest bill would therefore equal around five and a half years of all the tax collected by the New Zealand Government. 

The increase would not arrive immediately because government debt is borrowed for different periods. A 10-year bond issued at 3% continues paying 3% until it matures. The cost rises gradually as old debt is replaced with new borrowing at higher interest rates.

The United States is also adding more debt. Its government is expected to spend about US$1.9 trillion more than it collects this year. Interest costs are forecast to consume an increasing share of government revenue over the next decade.

New Zealand’s position is less extreme, although our room to respond is limited. Budget 2026 forecast an operating deficit of around $12 billion and government debt of approximately $192 billion in 2025/26. Debt is forecast to reach about $241 billion by 2028/29.

The Government will release updated figures on 29 September. These forecasts are likely to show debt continuing to rise for several years before eventually beginning to stabilise.

Economist Cameron Bagrie has also raised concerns about New Zealand’s long-term growth rate. This is the rate at which the economy can grow without creating more inflation.

Budget 2026 assumed average long-term growth of 2.1% a year. The equivalent forecast in 2023 was 2.9%. Bagrie estimates that the difference could leave the economy almost 3% smaller after four years and reduce government tax revenue by more than $4 billion.

The latest GDP result is encouraging, but one stronger quarter does not resolve New Zealand’s productivity problem. If the economy grows more slowly, government tax revenue will also grow more slowly.

At the same time, higher bond yields increase the cost of government debt. More tax revenue must then be used for interest payments, leaving less available for health, education, pensions, defence and infrastructure.

Heavily indebted governments eventually face three choices. They can increase taxes, reduce spending or continue borrowing. None of these options represent an easy answer.

The global economy will struggle to absorb repeated interest-rate increases without consequences. Households, companies and governments all carry large amounts of debt. Each additional percentage point means more income is spent on interest and less is available for consumption, investment or public services.

For many years, governments could borrow at exceptionally low rates. That period has ended. Government bond yields around 5% require a different discussion about how much debt countries can comfortably carry.

If these pressures continue, the type of ama-gi approach we have discussed before may return to the conversation. This would involve governments looking for less conventional ways to manage large debt burdens when higher taxes, spending cuts and continued borrowing all become increasingly difficult.

Oil began this latest inflation problem, but the interest rate response may eventually cause more economic damage. Air New Zealand, trucking companies, farmers, food producers and retailers are already deciding how much of the increase they can absorb and how much they must pass on.

Households could therefore face higher prices and higher mortgage rates at the same time. Governments will also pay more to refinance their debts, leaving less money for other priorities.

Oil prices could still fall, businesses may continue absorbing costs and the October inflation figures may show that wider price pressure is easing but for now, the combination of stronger GDP, a weaker New Zealand dollar, oil above US$100, higher government bond yields and the Federal Reserve’s latest increase has shifted the balance.

An OCR increase to 3.00% on 28 October now looks more likely than a continued hold at 2.75%.

Auckland Seminar

Our last seminar will be held next week in Auckland.

The seminar is open to both existing clients, friends, families this year and other investors.

The Auckland seminar will be held at Fairway Events Centre, North Shore, at 11:00am on Wednesday, 23 September.

We will discuss the current investment environment, recent developments across New Zealand and international markets, risk management, and some of the companies and sectors we are currently watching closely.

If you would like to attend the seminar, please contact us by email to reserve a place.

Bond issues

Metlifecare has announced a new senior secured bond, likely opening next week. 

The bond will have a term of 6 years, with an interest rate of at least 6.00% per annum.

Metlife is expected to pay the brokerage costs on this offer, however this will be confirmed next week once the deal opens.

Contact Energy is expected to issue a new subordinated capital bond in October. We expect the bond to have a term of around 6 years, with an interest rate of at least 6.00% per annum.

Investors who may be interested in these potential bonds are welcome to contact us with their CSN and an indication of the amount they may wish to invest. 

We will then contact them once the final terms and further details are available.

Travel

Our advisors have an extensive travel schedule coming up over the next quarter, including the following dates:

24 September – Ellerslie, Auckland – Chris Lee

25 September – Ellerslie, Auckland (AM only) – Chris Lee

25 September – Palmerston North – David & Gavin

5 October – Napier (Havelock North) – Edward Lee

5 October – Nelson – Chris Lee

6 October – Napier (Mission Estate) – Edward Lee

6 October – Blenheim – Chris Lee

9 October – Wellington – Gavin Parkes

21 October – Auckland (Albany) – Edward Lee

22 October – Auckland (Ellerslie) – Edward Lee

We will also visit Christchurch, Wellington and Lower Hutt in November. Dates to be confirmed.

Please contact us if you would like us to visit your area or would like an appointment.

Edward Lee

Chris Lee & Partners