Capital Economics believes that the Reserve Bank of New Zealand (RBNZ) will be forced to raise interest rates next year on the back of the tightening labour market:
The decline in the unemployment rate to 4.7% in New Zealand is consistent with our view that a continued tightening in the labour market will support the RBNZ to hike rates in 2022. The 0.6% q/q rise in employment was above the Bloomberg median forecast of a 0.3% rise and well above the RBNZ’s forecast of no change in employment in the quarter. What’s more, the rise in employment was more than enough to offset the 0.1ppt rise in the participation rate which meant the unemployment rate fell from 4.9% in Q4 to 4.7% in Q1…
In the quarters ahead a rebound in activity should further support the labour market. And forward indicators already point to strong labour demand with the recent surge in job ads consistent with the unemployment rate falling to around 4% before long. While the participation rate is still well below its pre-virus levels, we expect rising employment to reduce the unemployment rate in the months ahead. We think the unemployment rate will fall to near 4% by the end of 2022. That’s much more optimistic than the RBNZ’s forecast that the unemployment rate will rise to a peak of 5.2% in Q2 and remain above 5% until the end of 2022. Our view that the labour market is set to tighten much faster than the RBNZ anticipates is one reason why we expect the Bank to begin raising rates by the end of next year.
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I disagree with this assessment. Recent policy changes by the RBNZ and the Ardern Government are likely to stall the housing market, taking pressure off the RBNZ to raise rates.
First, the RBNZ reintroduced loan-to-value ratio (LVR) mortgage restrictions, which from 1 March 2021 required both investors and owner-occupiers to hold bigger deposits:
These LVR rules will officially reach their full scope on 1 May 2021 when the 40% deposit requirement kicks in again for investors.
Second, and more importantly, the New Zealand Government on 23 March announced major property tax reforms targeted at investors, specifically:
- extending the term of the Bright Line Test for taxing capital gains on investment property from five years to 10 years; and
- fully removing the tax deductibility of mortgage interest payments on residential investment properties.
New Zealand’s recent rapid house price appreciation was driven by investors, as illustrated by their rapid rise in mortgage lending:
The above policy changes will whack investors hard, putting significant downward pressure on property demand and prices.
Already there is evidence that New Zealand’s property market is slowing.
CoreLogic also expects the residential property market to slow as policy changes bite:
“There are signs that there are fewer buyers talking to banks about issuing them mortgages to buy another property”, CoreLogic Head of research Nick Goodall said.
From now, the impact of the official reimplementation of the LVR is expected to cool the market.
Goodall said anecdotes throughout April were of quieter open homes, a greater share of auctions “passing in” and fear of over-paying having replaced buyers’ fears of missing out.
In any event, the RBNZ today flagged that it would roll out further macro-prudential tightening if necessary. It also warned of a possible housing market correction:
If the RBNZ was to use a new tool, it said debt-to-income ratio restrictions “would be the best option for supporting financial stability and sustainable house prices over the medium term”…
“The recent tightening in LVR requirements, particularly for investor lending, will help to mitigate some of these housing risks and support more sustainable house prices…
“More recently, the Government’s extension to the bright-line property tax and the phased removal of interest expense deductibility will over time reduce the returns on investment property, particularly at high levels of leverage.
“Taken together, the various downside risks to house prices mean that the likelihood of a significant correction has increased.”
Lifting interest rates would turn a possible housing correction into a likely crash. For that reason alone, the RBNZ will be loathe to lift interest rates.
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