Two bank economic reports have been released today anticipating ongoing strong house price growth in New Zealand irrespective of whether the Reserve Bank of New Zealand (RBNZ) implements loan-to-value ratio speed limits, which will force the RBNZ to raise interest rates from 50-year lows.
New Zealand’s established housing market is booming. A combination of low policy rates and supply-side constraints in Auckland and Canterbury has supported a rapid rise in housing prices and a solid pick-up in turnover.
Inward migration is also beginning to pick up more broadly in New Zealand, which should further support the market and could more than offset the impact of a recent rise in fixed mortgage rates.
Double-digit house price growth is looking likely this year for the first time in over five years. Our modelling – which follows RBNZ internal methods – suggests house prices could rise by over 10% this year and we are forecasting growth of 9% in 2014.
Overheating in the housing market is very much a concern for the RBNZ at the moment, both in terms of its implications for financial stability and for generalised inflation. Public consultation on the possible usage of ‘macro-prudential tools’ by the RBNZ has been ongoing in recent months, with an announcement expected soon. If implemented, we expect the RBNZ would impose restrictions on loan-to-valuation ratios (LVR). While this could be a minor brake on the housing market, we don’t expect a policy change like this to be a game changer, given that rising housing prices are largely being driven by fundamental factors: strong demand and weak supply. In our view, house price inflation is unlikely to moderate significantly until policy rates begin to rise.
The RBNZ has begun to note its concern about the wider inflationary consequences of the strong New Zealand housing market. This is a change in rhetoric, with previous commentary mostly focused on the financial stability risks. A stronger housing market is one reason the RBNZ may need to consider lifting rates later this year.
There has also been a notable shift toward fixed rate mortgages in recent months, which could have implications for monetary policy. More mortgages on fixed rates could reduce the effectiveness of policy rate changes, another factor encouraging an earlier RBNZ hike…
So the question remains, what are the implications for monetary policy? We see stronger house price inflation than the RBNZ is currently assuming (RBNZ forecasts are for 9% in 2013 and 2014). As such, we see a greater boost to housing-related inflation pressures (for example, rents and housing construction costs) and to the consumer sector. A stronger housing market is one reason the RBNZ may need to consider increasing rates sooner, rather than later.
At the same time, the transmission of monetary policy may be becoming less effective due to the shift towards mortgage rate fixing. Recent months have seen a notable shift in new borrowing away from floating rates and towards fixed rates (Chart 8).
Floating rate mortgages now account for around 48% of total loans, down from 63% in April 2012. With a greater proportion of borrowers on fixed rates, this decreases the efficacy of the RBNZ’s policy rate, and may be another factor encouraging an earlier move in the overnight cash rate.
The RBNZ has noted growing concerns over the inflationary consequences of a strong housing market, one factor that may see them need to lift rates this year, ahead of the current market pricing for a Q1 2014 hike.
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In a seperate report, Westpac NZ’s chief economist, Dominick Stephens, argues that a debt-fueled rise in domestic consumption will force the RBNZ to raise the Official Cash Rate from 2.5% to 4.5% over the next three and a half years, which will push-up mortgage rates to around 8%. Stephens also warns of the potential for an eventual hard landing, particularly in the event that rising interest rates coincides with the wind-down of the Canterbury earthquake reconstruction.
The economy is showing all the signs of a self-reinforcing upswing, led by a surging construction sector and fuelled by low interest rates. We don’t expect the recent fall in the NZ dollar and the RBNZ’s planned restrictions on mortgage lending to throw the economy off that course.
…most other recent economic data have ranged from encouraging to stunning, suggesting the wider economy has weathered the drought better than we feared three months ago. Business and consumer confidence are at or near three-year highs; retail spending is growing at the fastest annual pace since the Rugby World Cup in late 2011; manufacturing and services activity surveys are in healthy expansion mode; and the government’s tax take keeps coming in ahead of plan…
House prices are 8.4% higher than a year ago, with prices in Auckland rising at more than twice that rate, and Canterbury prices also outstripping the rest of the country. Supplies on the market are undoubtedly tight: listings are near record lows compared to sales…
As for the housing market, we have long expected rising house prices to stimulate consumer spending, much as in previous economic cycles. That view presumed that the ‘deleveraging’ dynamic that was such a feature of the post-2008 period would run its course. Recent developments keep pointing in that direction. Household debt is rising at a roughly 5% annual pace – comfortably faster than household income. And in the latest Westpac McDermott Miller consumer confidence survey, the share of respondents saying they would spend a windfall (rather than bank it or use it to repay debt) was the highest since the mid-2000s. That is just the kind of scenario in which a rising housing market is likely to spill over to the wider economy…
The lift in construction has predictably boosted demand for related industries such as engineering. But other sectors may now also be riding the construction wave. The ties between the manufacturing sector and domestic construction are stronger than is often acknowledged. While non-food manufacturing was a surprising area of weakness in the March quarter GDP data, the manufacturing PMI survey hit a 9-year high in May. Given the soggy state of equivalent surveys internationally, that suggests local factors are at play…
Most notably, the labour market is finally improving. The sharp fall in the unemployment rate reported for the March quarter, to 6.2%, may to some extent be statistical ‘catch-up’. But the direction chimes with a lift in businesses’ reported and expected hiring in recent surveys, and with a steady improvement in households’ employment confidence. Improving job opportunities (and fewer on the other side of the Tasman) have in turn led to a marked lift in net immigration, which will further boost housing
market pressures…
We forecast house prices to rise 8.5% this year and 6.5% next… We continue to expect that substantial interest rate rises will eventually be needed to put New Zealand’s economy back on a more sustainable track. And with all the recent signs that the upswing is developing a life of its own, we remain concerned about the potential for an eventual hard landing – particularly if the peak in interest rates coincides with the wind-down of the Canterbury rebuild…
We have also long cautioned that this economic upswing has a darker side. It mostly reflects stronger domestic spending rather than export revenues, and some of this spending is being funded by debt. That cannot go on forever, and nor will the Canterbury construction boom…
The virtuous circle will keep turning for a while yet, but not forever. This is a classic demand cycle, fuelled by the Christchurch rebuild, rising house prices and debt. A slowdown will eventually follow. There hasn’t been a step change in New Zealand’s economic performance.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
