'It’s the biggest real house price downturn we’ve had since the 1970s'

ASB chief economist Nick Tuffley is styling the current housing market downturn as the biggest since the 1970s.

"A house as a unit of value is actually bleeding quite a bit of cash at the moment," Tuffley told an S&P Global Ratings 'Breakfast with the economists' virtual meeting on Tuesday.

House prices have dropped around 8% since peaking in November of last year and more is expected yet - as Tuffley noted..

"I think this downturn we are going through - it’s the biggest real house price downturn we’ve had since the 1970s.

"We sort of estimate somewhere around 20% [from peak to trough], give or take, in real terms, which is more than during the Global Financial Crisis downturn. So, it is quite sizeable when you look at it in that regard."

ANZ chief economist Sharon Zollner, who is forecasting an all-up fall of about 15%, said "in our forecasts, and I think most people’s forecasts, we are about half way through the fall in house prices".

"But the question I’ve got in my mind is how much of the absolutely necessary and inevitable real fall in house prices, how much of it is going to come through nominal house prices and how much is going to come through the general price level.

"You can imagine a scenario where if wage growth in particular holds up and the neutral OCR - the Official Cash Rate - creeps higher then you can imagine nominal house price falls petering out before that 15%.

"So, while there is still downside risk, particularly if the unemployment rate rises, I wouldn’t say the risks for nominal house prices are one way.  

"But I wouldn’t get too excited as a housing investor because I think anything you gain in nominal house prices you are still going to lose in real terms. It would just be the other side of the fraction doing the adjusting."

The Reserve Bank has been busily pushing up interest rates via the Official Cash Rate, which it has now hiked in four consecutive 50 point jumps to 3.0%. More is expected with the OCR now widely anticipated to reach 4% by the end of this year and peak at maybe a little over 4% by the middle of next year.

But in the meantime the RBNZ has indicated that it is reviewing its view of what the "neutral" rate is - which it currently measures at 2%. The neutral rate is perceived as the level at which rates are neither restrictive, nor stimulatory for the economy. Just right in other words. The RBNZ is not expecting to finish its work on this before the end of this year. 

The reason of course that the RBNZ has been hiking rates is to get inflation, which hit an annual 7.3% rate as at the June 2022 quarter, back under control and within the RBNZ's targeted level of 1% to 3%.

Zollner said if inflation doesn’t come down as quickly as people are expecting, the OCR is going to have to be kept up. (She has recently changed her call and is now forecasting the OCR will stay at 4% to the end of her forecasting horizon in 2024).

"It is not enough for inflation to turn. It has to drop fast," Zollner said during the S&P meeting.

"And I think that’s a risk that is under-appreciated by the markets. There’s a lot of uncertainty around how sticky and persistant inflation’s going to prove."

On the prospects for falling inflation, BNZ senior economist Craig Ebert said the headline inflation rates "could come down a lot".

"But again the trick is to understand the fundamentals and things like labour markets' capacity and we need to see those ease off to believe that the inflation decline is sustainable."

New Zealand's unemployment rate as per the June quarter was just 3.3%. And the extremely tight labour market is putting upward pressure on inflation. All the economists were viewing developments in the labour market as crucial.

Asked what the Reserve Bank viewed as a 'disinflationary' level for New Zealand's level of unemployment, Zollner said the RBNZ "doesn’t like to talk about that explicitly because it can be very easily passed by the media as the Reserve Bank wanting people to lose their jobs".

She said the Reserve Bank has no control over the level of unemployment that is inflationary versus disinflationary, they just have to estimate and work with it.

"Their latest estimate is about 4.5% and we are well below that at the moment at 3.3%. In both their May and August [Monetary Policy] Statements they forecast the unemployment rate to get to about 5% [by 2025] and I think that can be quite reasonably be estimated as their estimate of what is required - although you won’t find that in their policy summary."

Zollner said we actually need a period of "spare capacity" in the labour market in order to head off the potential for a wage price spiral - "which is absolutely live at the moment".

"The issue for the Reserve Bank is that the labour market lags the real economy, which of course lags what they do."

On the question of whether the RBNZ may yet need to 'do more' to quell inflation, Ebert said: "Well it is conceivable.

"There are still so many scenarios  that could play out ahead. Everybody is  sitting here at the moment thinking ‘well this inflation issue has come up on us, central banks are finally reacting. We will very soon properly get on top of it and we will all lick our wounds out the other side’.

"There are still a range of scenarios and that’s one of them. The other one is that central banks do just keep on plugging away and they do really slow things down a lot. Inflation comes down a lot and everybody’s thinking, well, gosh the market pricing for rate cuts next year is a valid one, which is the basis we are working off. But again there are scenarios where the core rates of inflation are sticky and that relates back to where the labour market goes."

In terms of relieving labour market pressures, Tuffley noted that the current Government was being cautious about letting migrant workers coming in.

“It’s almost a bit farcical where they are reluctant to give nurses instants residency to come to New Zealand, rather than making them wait two years when they get here out of fear they might disappear to Australia. Well, they’ll probably go to Australia first up if that’s where they want to go because it is much easier to get there.

“So we are putting a few roadblocks in the way in that immigration policy.

"It is probably the short term solution if we can get more people in to help alleviate some of those skill shortages."

Tuffley said work ASB economists had done recently studying the home grown labour supply looking out into the future had been quite sobering.

"The upshot is when you combine shifts in our demographics and potentially some pretty modest immigration - look our labour supply growth is potentially going to be very weak compared to what we have been used to.

"So, we actually probably have not just a near term challenge but potentially a challenge for quite a number of years where we are going to struggle to find people. We are competing in a global world for people. We are making it probably a bit tougher for ourselves than other countries in terms of attracting people here and our home grown labour force is going to be slow.

"So we are going to have to focus hard on how we adapt to that world as employers and organisations because we are going to have to look very hard at how we attract, retain people and do we really need to be stepping up our investment to try and boost productivity and find labour saving ways of doing business."

As a closing question the economists were asked how they viewed the economy, interest rates and inflation over the next 12 months.

Zollner said: "I’m seeing the risks very much skewed to the upside."

She said if inflation doesn’t come down quick enough "and maybe the neutral cash rate is creeping higher than the Reserve Bank is assuming"  there could be "a slow realisation" that  "maybe you just need to do a bit more and then a bit more. I think that’s quite a plausible scenario assuming nothing sudden comes along on the global front."

Ebert said: "None of the scenarios are particularly appealing."

He said the assumption is that the RBNZ will through raising the OCR slow the economy down and inflation pressure will come down.

"The difficulty is does that turn into something a bit nastier?

"And you can just run the risk where it all gets a bit ugly going forward.

"So soft landing is the best case scenario and that involves a lot of slow down and keeping things pretty cool. But again emphasis on keeping an eye on the supply side of the economy. What can we do to help the supply side of the economy. It might mean assisting businesses, compliance costs. Those sorts of things we chip away at. We talk about migration. What levers we could pull there to help get us through.

"But fundamentally it’s going to be bumpy, we just hope it doesn’t get particularly bumpy."

From an international perspective, S&P Global Ratings global chief economist Paul Gruenwald in New York said he thought central banks have a still "a relatively sanguine scenario" where they can raise rates a little bit above neutral and get inflation expectations "re-anchored at 2%" and bring wages and the labour force into "a golden sweet spot of not too much pain".

"I think the risks around that are to the downside…or to the upside on rates.

"It’s very plausible that central banks will need to do more. That spending will continue to be robust and maybe we have to be a little more aggressive on the rate cycle and cause a little bit more pain," Gruenwald said.

"I’m afraid on the risk side that is an increasing likelihood about where we could be going over the next 12 months."