New Zealand’s services sector recorded its strongest performance in nearly three years in August, extending a tentative recovery and providing another indication that the economy is regaining momentum even as higher borrowing costs and elevated living expenses continue to constrain households and businesses.

The BNZ-BusinessNZ Performance of Services Index, or PSI, increased to 51.2 in August from 50.6 in July. The latest reading was the highest since September 2023 and kept the index above the 50-point threshold separating expansion from contraction for a third consecutive month. The result followed readings around the breakeven level in June and July after a prolonged period of weakness earlier in 2026.

The improvement represents a potentially important shift for an economy whose recovery has been uneven across sectors. Services account for a large share of domestic economic activity and are particularly exposed to household consumption, labor-market conditions and confidence. Sustained expansion in the PSI would therefore provide stronger evidence that the recovery is moving beyond export-linked businesses and manufacturing into the broader domestic economy.

The August survey nevertheless showed that growth remains narrow rather than broadly based. New orders and business activity were the clearest source of forward momentum, with the new-orders sub-index rising to 55.2. Stocks and inventories registered 50.8. Three of the five main components remained below the neutral 50 level, illustrating why BusinessNZ continues to characterize the recovery as fragile rather than decisive.

Employment remained one of the most important weak points. The employment sub-index stood at 49.4 in August, remaining in contraction territory even as the headline measure strengthened. Supplier deliveries were weaker at 49.0. The divergence between rising orders and subdued employment suggests that services companies are experiencing some improvement in demand without yet gaining sufficient confidence to accelerate hiring materially.

That pattern has persisted during the initial phase of the recovery. In July, the PSI stood at 50.6 while employment was 48.5. BusinessNZ said at the time that firms remained cautious about committing to additional employees, reflecting continued uncertainty around household demand. New orders were already expanding more strongly than employment, providing an early indication that demand could improve before the labor market.

The August result therefore strengthens the argument that services activity has passed its weakest point, but it does not yet establish a vigorous domestic expansion. Business sentiment within the survey remained cautious, with 60.8% of respondent comments classified as negative. Cost-of-living pressures, interest rates and uncertainty surrounding the political environment were among the issues cited by businesses.

Those concerns matter because the services recovery is unfolding against a complicated macroeconomic backdrop. New Zealand’s inflation rate rose to 4.1% in the June quarter, driven substantially by higher fuel prices linked to the Middle East conflict. The increase pushed headline inflation above the Reserve Bank of New Zealand’s 1% to 3% target range, even though underlying measures showed less persistent inflation pressure.

The Reserve Bank responded on September 2 by raising the Official Cash Rate by 25 basis points to 2.75%. Policymakers said the increase was intended to prevent the temporary fuel-price shock from becoming embedded in broader price and wage setting while still allowing the economic recovery to continue. The central bank has also indicated that further increases could be required if inflation pressures prove more persistent than expected.

The improved services reading creates a nuanced signal for monetary policy. On one side, stronger activity supports the Reserve Bank’s assessment that the economy has resumed its recovery after lacklustre growth in the June quarter. On the other, policymakers will need to determine whether improving demand begins to generate additional domestic inflation at a time when headline price growth is already above target.

The central bank’s September Monetary Policy Statement said the recovery remained uneven. Strong export prices and resilient demand from major trading partners have supported income and investment in export-oriented parts of the economy, while weak income growth, job insecurity and subdued house prices have continued to weigh on household spending and residential investment. The August PSI is important because it provides tentative evidence that some domestically oriented services businesses are beginning to participate more fully in the rebound.

Still, the employment component suggests that improvement has not yet translated into a broad labor-market turnaround. The Reserve Bank has described unemployment as elevated and noted that employment growth has been insufficient to absorb all new entrants into the workforce. Weak employment conditions can restrain consumer spending by increasing precautionary saving and making households more reluctant to commit to discretionary purchases.

That dynamic has been visible in previous PSI reports. Earlier in 2026, BusinessNZ repeatedly highlighted pressure on consumer-facing industries such as hospitality, recreation and personal services. Higher spending on essentials, including fuel and food, reduced the income available for discretionary services. In May the sector remained in contraction, while June marked its return above the 50-point threshold.

The subsequent pattern has been gradual rather than explosive. The PSI moved into expansion in June, remained slightly above 50 in July and improved further in August. That sequence is economically significant because several consecutive expansionary readings provide a stronger signal than a single volatile monthly result. The 51.2 August reading also marks the strongest level since September 2023, underscoring how subdued the services environment has been for much of the intervening period.

Manufacturing indicators provide additional evidence that overall business activity is strengthening. The BNZ-BusinessNZ Performance of Manufacturing Index stood at 53.1 in August. Although that was down from 54.3 in July, it remained above both the 50-point expansion threshold and the survey’s long-term average of 52.5. Manufacturing employment was at the breakeven level of 50.0, while new orders and finished stocks remained in expansion.

The combination of an expanding manufacturing sector and an improving services economy offers a more constructive picture of third-quarter growth than the conditions prevailing earlier in the year. It is also consistent with the Reserve Bank’s assessment that the recovery likely resumed after weak second-quarter performance.

However, the composition of that recovery remains important. Export-oriented parts of New Zealand have benefited from resilient global demand and relatively strong agricultural commodity prices, while households remain more exposed to elevated living costs and borrowing expenses. An expansion that depends mainly on external income would have different implications for employment, consumption and inflation than one driven by widespread domestic spending.

The August PSI therefore places particular emphasis on new orders. At 55.2, that component was comfortably above the neutral threshold and stronger than the headline index. New orders tend to provide information about potential future activity because they capture demand entering company pipelines rather than only work already completed. If the strength persists, businesses could eventually respond by raising staffing levels and investment.

For now, the gap between orders and employment indicates that many services companies remain cautious. After an extended period of weak demand and economic uncertainty, firms may prefer to increase utilization of existing employees before committing to permanent hiring. Higher financing costs can reinforce that caution, particularly for smaller companies that depend more heavily on bank lending or have limited capacity to absorb higher wage and operating expenses.

Inflation also remains a central constraint. The Reserve Bank has said much of the recent increase in headline CPI resulted from vehicle fuels, while inflation excluding vehicle fuels was 2.9% in the June quarter. That distinction matters because monetary policy cannot directly reverse an externally generated increase in global energy prices. Instead, policymakers are focused on preventing those price increases from spreading into persistent domestic inflation expectations, wages and service prices.

The September policy statement projected inflation would remain elevated during 2026 before returning to the 1% to 3% target range by mid-2027 and moving toward the 2% midpoint later. The Reserve Bank also said the OCR might need to rise further, although the future policy path is not predetermined and will depend on incoming evidence about inflation and economic activity.

That makes surveys such as the PSI increasingly relevant. If new orders continue to accelerate, employment moves decisively above 50 and activity broadens across services industries, the data would indicate diminishing spare capacity and a stronger domestic recovery. Depending on accompanying inflation indicators, such a development could reinforce the case for the central bank to continue gradually removing monetary stimulus.

Conversely, a continued pattern of positive headline activity combined with contracting employment and negative business commentary would suggest the expansion remains vulnerable. Companies may still be facing enough cost pressure and demand uncertainty to prevent the improved order pipeline from translating into significant hiring or investment. That would be consistent with a moderate economic recovery rather than an overheating cycle.

Business confidence surveys have also shown signs of optimism alongside inflation concerns. ANZ’s August Business Outlook reported business confidence at a historically high level and noted a further improvement in reported past activity, led by services. At the same time, firms continued to report substantial cost pressures and inflation expectations edged higher, illustrating the same tension visible in the PSI between recovering activity and an unsettled inflation environment.

For households, the durability of the services recovery will depend heavily on the interaction between inflation, interest rates and employment. Higher fuel costs directly reduce disposable income, while a higher OCR influences mortgage and other borrowing costs. Employment growth would provide an important counterweight by improving household income security and supporting consumption.

For businesses, the August survey offers a more encouraging demand signal than was visible earlier in the year. Three successive readings above 50 and a new-orders index at 55.2 suggest that the sector is no longer simply stabilizing after contraction. The question is whether that improvement can become sufficiently broad to lift sales, deliveries and employment together.

The next several months will therefore be important for assessing whether August marks the beginning of a stronger phase or merely another modest step in a slow recovery. Continued PSI expansion alongside the manufacturing sector would support expectations for stronger economic growth in the second half of 2026. A decisive improvement in employment would be an especially important confirmation that businesses are prepared to move from cautious recovery toward expansion.

For now, the strongest services reading since 2023 adds to evidence that New Zealand’s economy is moving in a more positive direction, but the details remain consistent with a restrained recovery. Demand is improving faster than hiring, negative business commentary remains elevated, and monetary policy is becoming less accommodative as the Reserve Bank responds to above-target inflation. The August PSI therefore signals progress without eliminating the principal risks facing the domestic economy.