Graeme Wheeler says the 'trend' of lower interest rates, asset price appreciation and a high NZ dollar 'may finally be turning'; warns on housing market that 'soft landings' after a boom are rare

By David Hargreaves

Reserve Bank Governor Graeme Wheeler is hinting that last month's interest rate cut may be the last for the foreseeable future - and he's warning again about the overheated state of the housing market.

In a speech in Greymouth Wheeler cited "several cross-country studies", which have assessed the economic implications of housing market downturns. 

Boom-to-bust

"This research tends to show that almost half of the housing booms end in a bust, with downturns lasting around four to six years.

"In addition, soft landings in the residential investment cycle are rare, with most collapses leading to protracted falls in private consumption and investment, especially construction investment."

Wheeler said even though it is too early to be sure, there are some indications that house price inflation in Auckland and other regions may be moderating. 

"This may be a result of the increase in loan-to-value restrictions [requiring 40% deposits for investors], higher funding costs being experienced by banks, and tighter credit criteria being applied by banks in connection with financing apartment development and house purchases by offshore residents."

Challenging monetary policy

Monetary policy has been made more challenging in New Zealand by low global inflation and zero or negative policy rates in several major economies, Wheeler said. 

"This has put downward pressure on our interest rate structure and contributed to asset price inflation and upward pressure on the New Zealand dollar. This trend may finally be turning," he said.

“At this stage, global and domestic developments do not cause us to change our view on the direction of monetary policy as outlined in the November MPS [Monetary Policy Statement]. We expect monetary policy to continue to be accommodative, and that the projected policy settings will help generate sufficient growth to have inflation settle near the middle of the target range.”

The low point for CPI inflation has probably passed, Wheeler said, and, supported by the improvement in global commodity prices in recent months, the RBNZ expects the December quarter 2016 CPI data to confirm that annual CPI inflation is moving back within the 1% to 3% target band. 

Growth prospects promising

At this stage, the prospects for a continuation of New Zealand’s economic expansion with above-trend growth, strong employment and rising inflationary pressures looked promising, Wheeler said. 

"The main domestic risk (and one that could be triggered by developments offshore) is a significant correction in the housing market.  At this stage, however, the greatest threat to the expansion lies in possible international political and economic developments and their implications for the global trading environment."

Wheeler said numerous measures indicated that New Zealand house prices were significantly inflated relative to usual valuation indicators.

IMF data showed that New Zealand had the third highest real increase in house prices among 64 countries in the year to June 2016. New Zealand also had the greatest deterioration in the median house price to median income ratio of 31 advanced countries in the period 2010 to mid-2016. OECD data indicated that, relative to their long-term averages, New Zealand had the highest house-price-to-rent ratio, and the second highest house-price-to-income ratio among the OECD economies.

The Outlook

In the absence of major unanticipated shocks, prospects looked good for continued strong growth over the next 18 months, Wheeler said. 

This would be driven by construction spending, continued migration, tourist flows, and accommodative monetary policy. 

The RBNZ November 2016 MPS forecasts showed annual real GDP growth of around 3.75% over the next 18 months, with inflation approaching the mid-point of the target band, the unemployment rate continuing to decline, and the current account deficit remaining within manageable levels.

Historically, Wheeler said, expansions in small open advanced economies come to an end due to one or more factors:

• global economic growth weakens or slows in major trading partners and affects the terms of trade and export growth;
• a major domestic policy correction is needed to address a deteriorating fiscal or current account deficit;
• long-term interest rates rise significantly in response to offshore movements triggered by higher inflation expectations and/or increased risk premia in major economies.  Alternatively, domestic short-term rates may need to rise sharply to moderate inflation pressures associated with growing supply and demand imbalances.

"The main risks to the current expansion lie with future developments in the global economy, and a deterioration in the imbalances in the domestic housing market."

Downside risks

On the downside, the main risks were:

• the Euro-area economy remains subdued or deteriorates, with consumer and business confidence affected by developments relating to Brexit, migration and anti-globalisation sentiment;
• the incoming US Administration follows through on pre-election rhetoric relating to trade barriers, and abandons or renegotiates existing trade agreements;
• economic growth in China slows following a period of financial disruption linked to the very rapid build-up in corporate (mainly SOE) debt over the past 7 years, and a rising level of bad debts in the formal and shadow banking sectors.

"The main upside risk is that the US economy in 2017 grows more rapidly than the 2 - 2.25% growth currently projected by the IMF, OECD and BIS, due to substantial personal and corporate tax cuts and a large increase in infrastructure spending (with no major moves to raise trade barriers)."