Housing markets in some parts of the world are looking vulnerable to "even a modest rise" in interest rates - and New Zealand is pinpointed for attention in new research done by independent global economics researcher Capital Economics.
Capital Economics senior economic adviser Vicky Redwood says property markets "are the weak link" when it comes to the impact of tightening monetary policy.
"A modest rise in interest rates might only cause price falls in a few obvious candidates. But rates might have to rise only a bit further than we expect to cause more widespread falls. While this would not cause a second global financial crisis, it would still weigh on economic growth in the countries concerned and could cause interest rates to start falling again in some places.
"...Housing markets in some areas look vulnerable to even a modest rise in interest rates; we are most worried about Canada, Australia, New Zealand and Hong Kong. And there is a risk that interest rates will need to rise above their equilibrium in order to get inflation under control. In that case, we could be looking at more widespread falls in prices."
In fact Capital Economics Australia and New Zealand economist Ben Udy said in early January 2022 that he thought falling house prices in New Zealand would lead the Reserve Bank (RBNZ) to actually start DROPPING interest rates again from next year.
And he is sticking to that view.
"New Zealand’s high share of fixed mortgage rates won’t insulate the housing market from RBNZ rate hikes. Indeed, we’re sticking to our view that house prices will fall this year and cause the RBNZ to reverse course next year by cutting interest rates."
He's expecting the Bank to hike rates at every meeting this year, lifting the Official Cash Rate to 2.5% (it's 1% now).
"Home sales have slumped to a level consistent with prices coming to a standstill before long. If anything, the slump in home sales means that house prices could start falling even earlier than our current forecast," Udy says.
Vicky Redwood says that countries differ in how vulnerable their economies are to house price falls.
"Most at risk would be those that have relied heavily in recent years on residential investment (especially Canada) and those where the links between house prices and consumer spending are strongest (such as New Zealand)."
Redwood says property "looks overvalued" in some countries.
"For property markets in these places, even a modest rise in interest rates may well therefore prove too much.
"Chart 9 shows house price to income ratios relative to their long-run average for the biggest economies for which there are comparable data.
"While the equilibrium is likely to be higher than this long-run average, those that are furthest above their long-run average are most likely to be overvalued.
"Most notable is New Zealand, where the house price to income ratio is almost double its long-run average," Redwood says.
She notes that the latest data are for 2021 Q3 and rapid house price rises in the past few months and declines in income as government support has been withdrawn will have pushed up the house prices to income ratio further in the US in particular.
She says while it is not Capital's "central forecast", there is clearly "a significant risk" that interest rates end up rising above their equilibrium rates in order to get inflation under control.
"In that case, we would probably be looking at more widespread falls in house prices."
She says the "good news" is that even widespread property price falls would be unlikely to cause another global financial crisis. The rise in house prices over the past decade has not been accompanied by a prolonged loosening in credit conditions. Accordingly, household debt as a share of income has been stable and at a much lower level than seen ahead of the financial crisis.
"Having been propped up by low interest rates and bond yields for over a decade, property markets will certainly be tested as monetary policy tightens. How they fare will depend in large part on just how far interest rates rise and what impact quantitative tightening has on financial conditions.
"We think that most property markets can cope with a modest rise in interest rates. But there is still a huge amount of uncertainty about how high interest rates will need to go to bring inflationary pressures under control, uncertainty that has only been exacerbated by the further inflationary pressures stemming from the current war in Ukraine. And property prices do not look to be in a good place to withstand much bigger rate rises than we expect. That poses a downside risk to our forecasts for economic growth; in some countries, it is quite possible that weakening housing markets are what prompt interest rates to start falling again."
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