By Bernard Hickey
Reserve Bank Governor Graeme Wheeler has mounted a strong argument against calls to cut interest rates any time soon, saying the economy remained strong and there were still risks to financial stability and the wider economy from Auckland's resurgent housing market.
Calls for the Reserve Bank to cut its Official Cash Rate from 3.5% have grown in recent weeks as headline inflation has turned to deflation and other central banks eased monetary policy, including the Reserve Bank of Australia yesterday. Financial markets have also begun pricing in an OCR cut as early as March.
Wheeler used his first full speech of 2015 to push back against the calls and to warn again about the financial risks of high house price inflation.
However, he stopped short of suggesting new high LVR-style Macro-Prudential controls to slow the housing market, but he said the central bank was monitoring the role of the banking system in the housing market.
Housing over-valued
Wheeler spent some time looking at the housing market and how over-valued it was.
"Our concern about house price inflation is based on the risk it poses to financial stability and the broader economy," Wheeler said.
He pointed to IMF research from 2013 showing New Zealand having the second largest deviation from its historic average in the world behind Norway.
"Although it has not been a major factor in recent years, high rates of house price inflation can spill over into stronger spending and pressure on consumer price inflation. And the more that house prices get out of line with historic relativities, the greater the risk of a sharp correction, leading to financial instability," he said.
He said the bank would talk more about housing over the next few months.
Rate cut calls addressed
Wheeler directly addressed the rate cut calls in his speech.
"Some commentators have suggested that a cut in interest rates would be appropriate at this stage," said, noting that a major supply side shock such as lower oil prices could be an appropriate reason for a cut, as could a deterioration of domestic demand.
“However, in our current situation there are important considerations why a period of OCR stability is the most prudent option," Wheeler said.
“Commodity price declines reduce headline inflation for a period, but do not deliver a sustained decline in inflation. Weak or negative headline inflation is not reflective of underlying cost pressure in the non-tradables sector of the economy, and our medium-term forecasts and measures of core inflation are well within the target band," he said.
“New Zealand is the only country among the advanced economies that has had a positive output gap in the past two years, our unemployment rate is low and falling, net inward migration and labour force participation is at record levels, and business and consumer confidence surveys remain strong," he said.
"In addition, we have already seen some effective easing of credit conditions with declines in fixed-rate mortgages, at a time when we have financial stability concerns about accelerating house prices in Auckland." On the other side of the coin, Wheeler said the bank would need to be confident that capacity utilisation and labour market pressures were generating, or about to generate, a substantial increase in inflation before it could consider a rate hike.
The New Zealand dollar rose around half a US cent to 73.8 USc immediately after the speech, which appeared to hose down growing speculation about an imminent cut.
House price warning
Wheeler said the bank’s concern about house price inflation was based on the risk it posed to financial stability and the broader economy.
"Its focus is mainly on the Auckland and Christchurch markets, where the housing shortages are greatest and where market pressures are the most intense," he said, noting house price inflation appeared to be increasing again in Auckland.
“Resolving the housing shortages is key. In Christchurch, this issue is expected to be resolved, although with longer delays. But in Auckland, much more needs to be done, especially in creating opportunities for residential construction in Auckland," he said.
“We will continue to monitor housing developments carefully, and the role that the banking system may be playing in contributing to pricing pressures in the housing market.”
Exchange rate warning
Wheeler repeated his comments in multiple recent OCR statements and MPS statements that the New Zealand dollar was unjustifiably and unsustainably high.
"We believe that, over time, New Zealand’s growth differentials will narrow vis a vis the advanced economies, making the New Zealand dollar more likely to undergo a significant downward adjustment," he said.
Economist reaction
ASB Chief Economist Nick Tuffley said there were no details in the speech to show the Reserve Bank was seriously considering a rate cut in March.
"In verbal comments the Governor noted that non-tradable inflation and house prices are shaping the Bank’s thinking," Wheeler said.
ANZ Senior Economist Mark Smith said the Reserve Bank had stayed on message and there were limited market implications from the speech.
Westpac Chief Economist Dominick Stephens said the speech had poured cold water on financial market speculation about rate cuts.
"We suspect that some market participants (wrongly) interpreted last week's OCR Review as a gate-opener to imminent cuts," Stephens said.
"Consequently, this speech was a "hawkish" surprise relative to the median market expectation," he said, adding markets had priced out any chance of a March cut and the two-year swap rate had risen four basis points.
Some still saw the speech as opening the door for cuts, particularly in the wake of Australia's surprise cut. TD Securities Economist Annette Beacher said the speech may have been netural, but "they could be the next central bank to cut."
"Inflation has tipped into deflation and New Zealand’s real yields are some of the highest in the developed world. We now expect consecutive 25bp cuts in March and April to 3% if the RBNZ is serious about keeping the NZD under pressure," Beacher said.
"Today’s speech buys the RBNZ time to adjust to the new “central bank” world of 2015, where they say one thing and do another. We add the RBA to the growing list that includes the SNB, Bank of Canada and the MAS," she said.
Political reaction
Labour Finance Spokesman Grant Robertson said the Government had failed to deal with the housing crisis and had effectively outsourced it to the Reserve Bank.
“But Governor Graeme Wheeler clearly expects the Government to do its duty by saying today: ‘Resolving the housing shortages is key… in Auckland, much more needs to be done, especially in creating opportunities for residential construction’," Robertson said.
“In the diplomatic language of the Reserve Bank this means: ‘pull your weight Mr Key’. The Government should not leave the housing crisis to the Reserve Bank. John Key needs to build more houses in Auckland," he said.
(Updated with market reaction, more detail, political reaction)
21 Comments
The question you should be asking is why assume there is a fixed quanity of property?
Look around the world and you will see a massive expansion of floor space -they are called cities. Cities are not necessarily fixed in size. Only planning obsessed countries like NZ are trying to contain the size of its cities.
Changing interests rates doesn't affect the price of cabbages or TV because some of the demand response can go to increased production not prices. This stops the initial price movement which prevents a later hoarding/speculative price boom that is a feature of fixed or inelastic goods.
Pre and post GFC the cities in Germany and the US that have the attitude that the 'city air makes you free'. That newcomers should be given opportunities and one of those is the right to build did not have booms and busts in property prices. Despite these property boom/busts happening in other less 'elastic' cities in the same monetary area.
The December US housing report didn't quite get the coverage it deserved. Obama talked it up but it wasn't that great. Overall dwelling construction is down yoy. There is only one bright spot: standalone houses in the US South region.
This is the part of the country with the highest concentration of "right to build" type jurisdictions. This region didn't inflate house prices in the bubble, owners' debt levels were low enough that they could take a few hits, and now this region's economy is out of the starting blocks soonest.
And all because no-one could price gouge land prices up in these areas.
It's not hard.
I think you are stretching this a bit.
ie not likely, more like economics,
http://www.tradingeconomics.com/united-states/factory-orders
US Factory orders down and maybe at an increasing rate in the last 4 months, worth watching maybe.
Permits for standalone housing in US South rose 14% in December over the same time the year before. By comparison US MId and US West rose only 4% and US Northeast declined.
All permits for apartments and other denser forms of housing declined everywhere.
My take is that in the South, where land speculation and, therefore price gouging can't happen, household debt levels were lower than in other regions when the GFC hit. There was no bubble to burst so fewer people went underwater on their mortgages. Regional economies possibly fared a little better because a lower percentage of household income was needed to service debt. So they could spend more locally. You see how the virtuous circle goes.
The region is well placed to take advantage of the slow national recovery and that is reflected in demand for housing that is bigger than a doghouse.
If you have a better explanation I am all ears (or eyes in this case).
If you really want to gnash your teeth consider that the People's Socialist Republic of Austin, Texas which is only a little larger than Auckland is currently experiencing growth rates 50% higher than Auckland (including lots of migration) and has a median house price of $246,000. Same easy credit there and no macro-pru.
Maybe I am missing the point, but changes in OCR seem irrelevant when the major banks are calling all the shots. Since the OCR went up to 3.5% late last year one would have epected a rise in mortgage rates and a more gradual rise in interest rates offered to investors. What has taken place is the opposite... significantly cheaper short term mortgages.. a High Street war, and interest rates for investors over the two year period declining by approaching 20%. The war over mortgage rates is no doubt contributing to the escalating property market whilst savers are taking it on the chin, and like the USA will have nowhere to go other than the Stock Exchange or local casino to strive for a decent return on their funds. Therefore is the OCR of any relevance anymore or are the retail bankers in charge of our economy?
There are some wheeles within wheels. Deposit rates have declined for "investors" as the many OAPs ran from the finance debacle to a "safe haven" deposit accounts, hence an over-abundance of funds and hence why the rate has dropped.
"a rise in mortgage rates" this is what happened, my floating rate had risen slightly.
Cheaper mortgages are only now appearing as the banks can see the OCR wont be rising for 12+ months and could well drop instead.
Not "savers" but the saved by and large. Savers are ppl like me someone who works andsaving for retirement, I save what I can the rate doesnt matter. The saved on the other hand are the OAPs living on the interest and their capital may well be declining rather than increasing.
"decent return" well there we greatly disagree, considering its an almost zero risk of loss (compared with outside) then to me the rate looks a bit high still.
I good Q on the OCR it is still somewhat relevent, but actually now it could be a dangerous and damaging tool in the wrong hands.
In any event what to do with it? replace it with what? do away with it?
Wheeler came in and wanted to start raising rates early on. He seems to be happy wielding his only tool. Even when he started raising rates, everybody but the highly paid, experienced economists, said there could be issues - but he pushed on never-the-less.
He needs to read less into what happens in Auckland and look after the 'whole' of NZ. Until he does, the man is NOT for moving downwards.
Mr Wheeler seems to be giving very mixed messages. The exchange rate is up and down dramatically, such that you have to conclude the markets have little idea what are his priorities. Last week the OCR moves to neutral, and no mention of house prices. Today it's all about house prices. Would the major banks fail even with a 30% house price correction? Not even close. He seems to think the housing issue is supply driven. Not really his problem then.
His official target is the inflation rate, which he's missing by a mile. The most he mentions is that in the medium term his expectations are that it will be within the target band. No definition of the term, or whether he would expect it to play catch up to meet his "average over time" target.
He talks of the exchange rate being unjustifiably high, but surely had to know that if he focussed on house prices, that the exchange rate would go higher still.
Am afraid he wouldn't get high marks for communication; in particular for making it clear what his priorities are, how they fit in with his mandate, what he's doing about them and what he's not, and how he expects all that to achieve his targets over time.
SL. A house price fall like that could well prove fatal for some bank(s). Shocks such as that don't happen in isolation, they compound right through the economy. Hitherto illegal Covered Bonds would strip the prime assets out of NZ hands and the OBR would seize Kiwi's bank accounts. A nightmare.
Ergophobia
Ergo,
If we were talking about a 30% drop in Auckland prices, given Auckland is pretty clearly the main market where prices have risen based on speculation rather than pure fundamentals, then from Gareth Vaughan’s article on median house prices, such a drop would get prices back to 2009 prices. Anyone who bought before then would be no worse off, although I accept would feel less wealthy. The mortgage debt of course follows the indebted, rather than links to the house as in the US, so those owing the money to the banks would still owe the same money, and arguably have the same income streams to pay it off as they do now. I accept such a move would suggest some other stresses and dislocation in the economy, such that ability to pay might well have suffered for some; highly leveraged property investors in particular.
Presumably such a move down would elicit as an early response some drop in the OCR in any case, so that mortgage rates would drop.
I truly believe that any suggestion that such a drop would cause the NZ branches of the big four Aussie banks; or HSBC NZ, or Kiwibank to fail and give up their money printing licences here, is fanciful.
So why is Wheeler worried about house prices when they otherwise are not in his brief?
Perhaps they should be in his brief, as I personally accept the NZ economy is ridiculously geared to property investment, and not otherwise making goods and services that the world wants. But then if he thought that, he would be more mindful of the exchange rate and capital flows than he seems to be. He talks about the exchange rate, but even a casual observer can see that the market totally ignores his rhetoric about unsustainable levels, while his instincts are to keep the OCR the highest in the advanced world.
His brief is inflation 1-3%, and 2% over a period. He's going to miss it by some margin, for a sustained period, by his own admission, and his copout seems to be house prices, which are not his brief other than bank failures.
SL. I hope we never get to test which one of us is right. The reason markets ignore Wheelers' ravings about the NZD being overvalued, is because it isn't. It reflects the relative prosperity of our economy compared to dog-tucker others. Just wait and see what happens when the Yanks DON'T raise interest rates.
Are the people with "the same income streams to pay it off as they do now." going to be defaulting? only if they have lost their income and that would take a serious unempolyment kick up, but why would that happen.
I tend to think of NZ as one glued together deck of cards, if one card goes sure it all falls over but I am hard pushed to say why one card would fall. hence my eyes are firmly fixed abroad at a major event.
"his brief" I wish I could see inside his head. Is it dogma that is stopping him reducing the OCR? or some real concern?
I am not sure what you are saying here.
a) The OBR does not seize kiwi's bank accounts, quite the opposite, only their deposits, chequing accounts stay working that is the idea.
b) Depositors have one big advantage over a covered bond, they can leave before hand at close to a moments notice. So depositors need an exit strategy like say buying short term govn bonds so the bank cannot claw it back. I would think that a professional advisor should be able to advise on how this is done before hand and you jsyt sit there with the detailed information ready to act on.
c) I cannot fathom why or how house prices would decline over-night without a good reason and notice IMHO.
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