As New Zealand enters the third year of the COVID-19 pandemic, a leading bank economist expects economic growth to slow.
In an economic overview report released on Tuesday, Westpac acting chief economist Michael Gordon says the price of the country's largely successful approach to managing COVID-19 is now revealing itself.
Buoyed by Government and monetary policy stimulus, strong economic recovery is "running up against capacity constraints", Gordon says in the report.
While economic activity is expected to "remain firm" this year, conditions are mixed across the economy.
The Omicron outbreak and public health measures are expected to dampen economic growth in the early part of this year.
The number of workers in self-isolation is expected to increase, raising the risk of high absenteeism. Rising case numbers are also affecting the hospitality and tourism sectors.
Wages are coming under pressure as businesses continue to report difficulties finding workers. Global supply chain disruptions are resulting in shortages in materials and finished goods. Some sectors are facing large increases in operating costs.
"We're already running hot…it's difficult to extract more growth on top of where we already are," Gordon tells Newshub.
The introduction of policy stimulus, which saw the official cash rate drop to a record-low 0.25 percent in March 2020, boosted demand.
The official cash rate, currently 0.75 percent, is on the rise, with Westpac forecasts showing it will peak at 3 percent by the second half of 2023.
"Just as the introduction of this stimulus boosted demand, its withdrawal will be a drag on growth," Gordon says in the report.
Fixed mortgage interest rates have "risen sharply off their lows" and are already nearing their highs for this cycle.
Rising interest rates are increasing costs for borrowers.
House price growth is showing signs of slowing, Westpac forecasts showing a 5 percent decline in housing prices over the coming year, in response to higher interest rates.
As the housing market influences household wealth, a moderate fall in house prices is expected to influence willingness to spend.
"We've reached that point in terms of cooling the housing market… the Reserve Bank now needs to let that play out and follow through with those cash rate increases that have already been baked in [to fixed mortgage rates]," Gordon adds.
Westpac is forecasting inflation, currently 5.9 percent to peak at 6.3 percent in the March 2022 quarter, dropping below 3 percent from 2023.
But even as the overall inflation rate falls, the bank expects 'non-tradables' inflation (items for which prices are influenced by local conditions) to play a bigger role. There's a risk New Zealand's tight labour market and resulting demand for higher wages, pushes up prices.
"We're currently going through the peak in inflation, a lot of which has been due to a range of cost increases coming at once," Gordon tells Newshub.
"Over the course of the next year, the headline inflation rate will come down but it's going to be more driven by domestic factors than off-shore disruptions."
A measure of growth in national output, Gross Domestic Product (GDP) grew by 4.9 percent in the September 2021 year, current StatsNZ figures show.
Westpac is forecasting annual GDP growth of 3 percent this year.
Unemployment, currently 3.2 percent, is forecast to fall to 3 percent.
Relaxation of borders later this year will allow more skilled workers into the country, benefiting some sectors. Overall, Westpac still expects the labour market to remain tight.