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The turning worm can upset early birds

Stephen Toplis – 

However, while the good folk in Christchurch may be disappointed over the pace of the rebuild, there has categorically been a lot of it.

Indeed, so much so that the prospect of a future oversupply now looms.

At this stage, the possible oversupply of land is more immediate but in time, given land availability, it looks likely that demand for housing will be met.

Inflation bites

This is already being reflected in house price inflation which has fallen to zero from a peak of around 19% in late 2013. The possibility of house prices actually falling is now real.

There is nothing weird and wonderful about this process which is a clear signal to all that there\ is no reason why house prices should just keep going up of their own accord.

In the last major housing uplift (2003-2007), credit growth appeared to play a significant role in the process as speculative fervour added to the pressures on the sector from migration.

Equity withdrawal was all the rage then too.

Turning worm

We had said that the cycle was a lot less sinister as credit growth had remained constrained and there was no sign of equity withdrawal. However, the worm may be turning.

After a period of very low credit growth from mid-2008 to mid-2012, there was a step change higher to around 5% annual rates of growth in lending to households.

While higher than the trough credit growth still did not look particularly exciting.

But the hike reported for May is very interesting.

If this is a sign of things to come, credit growth could soon be back at double-digit annualised rates. If this becomes the norm, upward pressure on house prices will be heightened alongside financial stability concerns.

Lowering interest rates does nothing but exacerbate this process.

Unique factors

Basic CMYKWhile there are some clearly unique things at play in New Zealand at the moment, it is worth noting that rising house prices are not just a New Zealand phenomenon.

Neither is high house price inflation in major centres.

It is important that policy makers differentiate between the things they may have some control over and those that are simply imposed.

The main reason for high house prices worldwide is that monetary conditions are extremely stimulatory. While such settings may not have created the goods price inflation one might have anticipated, inflation in asset prices is clear to see.

Quantitative Easing

With Quantitative Easing alive and well there is an excess supply of cash floating around the world looking for a home.

Accordingly, asset prices of all descriptions have been rising, especially those of property, equities, bonds, art and stamp collections.

Exacerbating this process has been ultra-low interest rates and the transfer of capital from places such as Eastern Europe, Russia and China.

One also cannot but wonder whether the real estate market has the same ability to monitor money laundering activity as financial markets, more generally, are now required to do.

Whatever the actual impact of the combination of the above, it is important to recognise that these forces are in existence and little can be done to moderate the impacts that are largely being driven from offshore.

Major concerns

There are two fundamental economy-wide concerns when house price inflation becomes too lofty and house prices become overvalued:

Will folk withdraw equity from the housing market and use this to increase consumption in a manner that creates excess demand and worrying levels of domestic price pressure? This being so interest rates would need to rise to contain both demand and price pressures. This is a monetary policy issue.

The other issue is the concern that house prices are becoming so extended that there becomes potential for a major future house price correction which undermines not only economic activity but, more importantly, puts bank balance sheets at risk given the extent of their exposure to the housing market.

Prudential issue

In a worst case scenario this could result in the sort of economic disaster that has afflicted parts of Europe over the last few years. This is a macro prudential issue.

The problem that the Reserve Bank of New Zealand (RBNZ) faces is that the current state of the housing market demands higher interest rates from both a monetary and prudential perspective.

But higher interest rates, through their impact on the currency, might generate deflation and defeat the RBNZ in its bid to get annual CPI inflation to 2%.

Stephen Toplis is Head of Research at BNZ, the Title Sponsor of the Indian Newslink Indian Business Awards 2015 and Sponsor of the ‘Best Large Business’ and ‘Supreme Business of the Year.’

Read another report in this section.

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