RBNZ's Slack Gauge: How Economic Capacity Will Dictate Oil Shock Response

The economy is in a fragile state, just beginning to turn positive after a contraction. GDP grew a weak 0.2% in the fourth quarter of 2025, missing expectations, and the annual rate of 1.3% also fell short. This follows a 0.5% GDP contraction in 2024, leaving unemployment elevated at 5.4% in Q4 2025. The recovery is described as lacking conviction, with growth now projected to accelerate later in 2026.

This backdrop is now facing a direct shock from energy markets. The war in the Middle East has sent Brent crude over US$100 a barrel for the first time since the Ukraine invasion, driving up fuel prices domestically. The RBNZ's chief economist notes this conflict is a key source of uncertainty for the projected "decent" growth this year.

The core question for policymakers is how to respond. With excess capacity in the economy and an output gap that is still negative, the central bank has room to look through the immediate inflationary pressure. The setup is clear: weak growth and high unemployment create a buffer against a full-blown cost-push crisis, but the oil shock introduces significant volatility.

The Policy Mechanism: Looking Through vs. Reacting

The RBNZ's framework is clear: it is meant to discount disturbances to inflation that are expected to be temporary. This mandate allows the bank to look through a spike in energy costs if it deems the pressure short-lived. Governor Anna Breman has explicitly stated that a short-lived disruption and a temporary increase in petrol prices can – and should – be looked through from a monetary policy perspective if it won't impact medium-term inflation outcomes.

This stance is directly supported by the current economic data. The bank's chief economist notes there is still excess capacity in the economy, so the output gap is still negative. With unemployment at 5.4%, this slack provides a buffer. The RBNZ is betting that this spare capacity will allow the economy to grow strongly this year without fanning inflation, which is why the bank has held the OCR at 2.25% since November.

Yet the Governor has issued a clear caveat. She will not rule out either rate hikes or rate cuts due to the uncertainty. The bank's vigilance hinges on whether inflationary pressures become entrenched. As the chief economist noted, the committee will run its ruler over all of that and figure out what that context means for the extent of those second-round inflationary effects. The next meeting on April 8 will test this balance, as markets now price a roughly 60% chance of a hike in May.

The Catalyst & Key Watchpoints

The immediate catalyst is the RBNZ's next Monetary Policy Committee meeting on April 8. The committee's stated focus will be running its ruler over the economic data to determine the extent of second-round inflationary effects from the oil shock. This is the precise mechanism that will dictate whether the bank leans against inflation or maintains its current stance.

The primary risk for entrenchment is core inflation. The bank's governor has made it clear that while a temporary spike can be looked through, the committee is vigilant to the risk that pressures spread more broadly. The key will be monitoring whether the recent rise in energy costs begins to feed into wage growth and broader price-setting behavior. A breach of the 3% target in the fourth quarter already shows the pressure is real.

A secondary, but important, watchpoint is the labor market. The exodus of Kiwis to Australia has helped keep unemployment lower than it otherwise would be. If this outflow slows, as the chief economist notes it appears to be doing, the labor market could tighten more quickly. This would reduce the spare capacity buffer and increase the risk of inflationary pressures becoming embedded.