As we all know, the housing market in New Zealand is enjoying a good year, with markets especially heated in (central) Auckland and Christchurch.
For near-term GDP growth, this helps in two ways. Firstly, higher house prices have a positive influence on consumer confidence and spending, as consumers loosen their purse strings as they watch the value of their largest asset increase.
Secondly, higher prices lead to higher numbers of new homes being built.
At a 3.5% share of GDP, residential house construction is not a large part of overall economic activity (GDP), but it is one of the most volatile components, both here and overseas. The improving home construction cycle in NZ is expected to add 0.7 percentage points to our GDP growth this year. The cycle will remain strong after that, in large part due to reconstruction in Christchurch. Indeed the RBNZ (Reserve Bank of New Zealand) forecasts that earthquake-related residential construction in Christchurch will account for 0.75-1% of NZ’s GDP in each of the 2014-2017 years.
That is the good news. However, this housing market strength creates several issues for our economy:
i) It is inflationary in a general sense, through its impact on growth, and on prices in the construction sector in particular;
ii) House purchases are, of course, to a large extent financed by mortgages. So, we are currently seeing increasing leverage across New Zealand’s already-levered consumer;
iii) Greater mortgage borrowing by NZ consumers tends to imply that our banks have to borrow more offshore, which increases our current account deficit.
These factors together push the Reserve Bank towards increasing interest rates, to cool the housing sector and reduce these pressures.
However, higher interest rates are not appropriate at present for several parts of the economy. Our labour market remains relatively weak, with unemployment at 6.9%. The rural sector is struggling amidst a severe drought. Further, all exporters are being hurt by the high currency – which would rise further if the RBNZ increased the cash rate.
So what can the RBNZ do in the face of this dilemma? Part of the answer is that they are looking at new ‘macro-prudential’ tools. One of these would be to impose Loan-to-Value (LVR or LTV) restrictions on banks’ mortgage lending. The LVR is the value of the mortgage, divided by the purchase price of the property. In a recent speech RBNZ Governor Graeme Wheeler noted that new lending above an 80% LVR is now 20% of the total – more than the 2006/07 peak of 18-19%. Potentially, the RBNZ could put an outright restriction on banks’ ability to lend at LVRs above this level (with a possible carve-out for first home buyers). Or, the RBNZ could ask banks to hold more capital against these high LVR loans (this basically makes it more expensive for banks to offer these loans, meaning they will have to increase the interest rates on them).
In trying to tame the housing market, any LVR restriction such as this would be less effective than simply increasing the cash rate. Home buyers would also try to find ways around it – top-up borrowing from family for example. These issues notwithstanding, LVR restrictions do offer a useful new tool for the RBNZ in managing this important sector of the economy.
Other things being equal, the use of LVR restrictions this year would help keep interest rates lower, which is a positive factor for stock market performance. It would also help reduce upward pressure on the New Zealand dollar.
With the RBNZ already seeking public consultation on these and other macro-prudential policy measures, we believe it is likely the RBNZ will introduce some form of LVR measures over the next few months. We would see this as a positive step, both for guiding the economy through its current pressures, and for the RBNZ’s long-term ability to manage different cycles in growth and asset prices.
Fixed Income Analyst