Archive | Reserve Bank

Housing supply the main concern as Reserve Bank holds cashrate

The Reserve Bank held the official cashrate at 1.75% today.

The bank cut its cashrate by 25 basis points in November, the third 25-point cut last year.

Bank governor Graeme Wheeler’s biggest concern was whether housing supply would start to address the imbalance in that market, but he noted that prices had drifted back.

Mr Wheeler said: 

“Macroeconomic indicators in advanced economies have been positive over the past 2 months. However, major challenges remain with ongoing surplus capacity in the global economy and extensive geopolitical uncertainty.

“Global headline inflation has increased, partly due to a rise in commodity prices, although oil prices have fallen more recently. Core inflation has been low & stable. Monetary policy is expected to remain stimulatory, but less so going forward, particularly in the US.

“The trade-weighted exchange rate has fallen 4% since February, partly in response to weaker dairy prices & reduced interest rate differentials. This is an encouraging move, but further depreciation is needed to achieve more balanced growth.

“Quarterly gdp was weaker than expected in the December quarter, but some of this is considered to be due to temporary factors. The growth outlook remains positive, supported by ongoing accommodative monetary policy, strong population growth and high levels of household spending & construction activity. Dairy prices have been volatile in recent auctions and uncertainty remains around future outcomes.

“House price inflation has moderated, and in part reflects loan:value ratio restrictions & tighter lending conditions. It is uncertain whether this moderation will be sustained, given the continued imbalance between supply & demand.

“Headline inflation has returned to the target band as past declines in oil prices dropped out of the annual calculation. Headline CPI will be variable over the next 12 months due to one-off effects from recent food & import price movements, but is expected to return to the midpoint of the target band over the medium term. Longer-term inflation expectations remain well anchored at around 2%.

“Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.”

Attribution: Bank release.

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Wheeler holds cashrate and sees change a long way off

The Reserve Bank left the official cashrate unchanged at 1.75% today, and indicated it would be a long time before change was needed.

Bank governor Graeme Wheeler pitted an improved global outlook against surplus capacity & geopolitical challenges, and once again argued that the $NZ was overvalued.

Mr Wheeler said in his statement on the cashrate decision:

“The recovery in commodity prices and more positive business & consumer sentiment in advanced economies have improved the global outlook. However, major challenges remain, with ongoing surplus capacity in the global economy and rising geopolitical uncertainty.

“Global headline inflation has increased, partly due to rising commodity prices. Global long-term interest rates have increased. Monetary policy is expected to remain stimulatory, but less so going forward, particularly in the US.

“New Zealand’s financial conditions have firmed, with long-term interest rates rising and continued upward pressure on the $NZ exchange rate. The exchange rate remains higher than is sustainable for balanced growth and, together with low global inflation, continues to generate ‘negative inflation’ in the tradeables sector. A decline in the exchange rate is needed.

“Economic growth in New Zealand has increased as expected and is steadily drawing on spare resources. The outlook remains positive, supported by ongoing accommodative monetary policy, strong population growth, increased household spending and rising construction activity. Dairy prices have recovered in recent months, but uncertainty remains around future outcomes.

“Recent moderation in house price inflation is welcome and, in part, reflects loan:value ratio restrictions & higher mortgage rates. It is uncertain whether this moderation will be sustained, given the continued imbalance between supply & demand.

“Headline inflation has returned to the target band as past declines in oil prices dropped out of the annual calculation. Inflation is expected to return to the midpoint of the target band gradually, reflecting the strength of the domestic economy and despite persistent negative tradeables inflation. Longer-term inflation expectations remain well anchored at around 2%.

“Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.”

Links:
Monetary policy statement
Monetary policy statement press conference live-stream at 10am
Graeme Wheeler reading statement

Attribution: Bank release.

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Wheeler cuts cashrate to 1.75%

The Reserve Bank reduced the official cashrate by 25 basis points today to 1.75%.

Bank governor Graeme Wheeler talked of adjusting to uncertainties, but without a timeframe.

In his release explaining the cut, he said: “Significant surplus capacity exists across the global economy despite improved economic indicators in some countries. Global inflation remains weak even though commodity prices have come off their lows. Political uncertainty remains heightened and market volatility is elevated.

“Weak global conditions and low interest rates relative to New Zealand are keeping upward pressure on the New Zealand dollar exchange rate. The exchange rate remains higher than is sustainable for balanced economic growth and, together with low global inflation, continues to generate negative inflation in the tradables sector. A decline in the exchange rate is needed.

“Domestic growth is being supported by strong population growth, construction activity, tourism, and accommodative monetary policy. Recent dairy auctions have been positive, but uncertainty remains around future outcomes. High net immigration is supporting growth in labour supply and limiting wage pressure.

“House price inflation remains excessive and is posing concerns for financial stability. Although house price inflation has moderated in Auckland, it is uncertain whether this will be sustained given the continuing imbalance between supply & demand.

“Headline inflation continues to be held below the target range by ongoing negative tradables inflation. Annual CPI inflation was weak in the September quarter, in part due to lower fuel prices and cuts in ACC levies. Annual inflation is expected to rise from the December quarter, reflecting the policy stimulus to date, the strength of the domestic economy, and reduced drag from tradables inflation.

“Monetary policy will continue to be accommodative. Our current projections & assumptions indicate that policy settings, including today’s easing, will see growth strong enough to have inflation settle near the middle of the target range. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.”

Link:
Monetary policy statement
Monetary policy statement press conference live-stream

Attribution: Bank release.

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Reserve Bank holds cashrate at 2%

The Reserve Bank kept the official cashrate at 2% today, with nothing unusual to say about prospects.

Here’s how bank governor Graeme Wheeler summed up the world’s economic conditions: “Global growth is below trend despite being supported by unprecedented levels of monetary stimulus. Significant surplus capacity remains across many economies and, along with low commodity prices, is suppressing global inflation. Volatility in global markets has increased in recent weeks, with government bond yields rising and equities coming off their highs. The prospects for global growth & commodity prices remain uncertain. Political uncertainty remains.

“Weak global conditions & low interest rates relative to New Zealand are placing upward pressure on the $NZ exchange rate. The trade-weighted exchange rate is higher than assumed in the August statement. Although this may partly reflect improved export prices, the high exchange rate continues to place pressure on the export & import-competing sectors and, together with low global inflation, is causing negative inflation in the tradables sector. A decline in the exchange rate is needed.

“Second quarter gdp results were consistent with the bank’s growth expectations. Domestic growth is expected to remain supported by strong net immigration, construction activity, tourism & accommodative monetary policy. While dairy prices have firmed since early August, the outlook for the full season remains very uncertain. High net immigration is supporting strong growth in labour supply and limiting wage pressure.

“House price inflation remains excessive, posing concerns for financial stability. There are indications that recent macro-prudential measures & tighter credit conditions in recent weeks are having a moderating influence.

“Headline inflation is being held below the target band by continuing negative tradables inflation. Annual CPI inflation is expected to weaken in the September quarter, reflecting lower fuel prices & cuts in ACC levies. Annual inflation is expected to rise from the December quarter, reflecting the policy stimulus to date, the strength of the domestic economy, reduced drag from tradables inflation and rising non-tradables inflation. Although long-term inflation expectations are well anchored at 2%, the sustained weakness in headline inflation risks further declines in inflation expectations.

“Monetary policy will continue to be accommodative. Our current projections & assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range. We will continue to watch closely the emerging economic data.”

Attribution: Bank release.

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Reserve Bank confirms loan restrictions go nationwide

The Reserve Bank confirmed yesterday that new rules will tighten restrictions on bank lending to residential property buyers throughout New Zealand.

From 1 October, residential property investors will generally need a 40% deposit for a mortgage loan, and owner-occupiers will generally need a 20% deposit. In both cases, banks will still be allowed to make a small proportion of their lending to borrowers with smaller deposits.

The bank confirmed the new rules in its response to submissions to its public consultation about changes to loan:value ratio (LVR) rules that it issued on 19 July. It said it was modifying its proposals in response to public consultation, and through meetings & workshops with banks that are subject to the rules.

Although the new rules take effect only on 1 October, the Reserve Bank said commercial banks had chosen to start following the new limits already.

Existing exemptions to LVR restrictions will continue to apply under the new rules and have been extended to include borrowing for a newly built home, or to do work needed for a residence to comply with new building codes & rental-property standards.

Summary of changes to LVR rules– main changes shown in red – first for borrowers who are owner-occupiers:

Previous: In Auckland, 10% of a bank’s total lending to owner-occupiers can be to borrowers with a deposit less than 20% of the house value. Outside Auckland, 15% of a bank’s total lending can be to borrowers with a deposit less than 20% of the house value

Change: For all of New Zealand, 10% of a bank’s total lending to owner-occupiers can be to borrowers with a deposit less than 20% of the house value

For borrowers who are residential property investors:

Previous: In Auckland, 5% of a bank’s total lending to residential property investors can be to borrowers with a deposit less than 30% of the house value. Outside Auckland, owner-occupiers & residential property investors are treated the same. 15% of a bank’s total lending can be to borrowers with a deposit less than 20% of the house value

Change: For all New Zealand, 5% of a bank’s total lending to residential property investors can be to borrowers with a deposit less than 40% of the house value. In Auckland, borrowers who include an owner-occupied residence in a portfolio of mortgaged houses are allowed to borrow up to 70% of the value of the entire property portfolio. For all New Zealand, borrowers who include an owner-occupied residence in a portfolio of mortgaged houses are allowed to borrow up to 80% of the value of their owner-occupier home and 60% of the value of their investment properties.

Exemptions from the LVR restrictions:

Previous: Loans to borrowers building a new residence are exempt. The exemption doesn’t apply for a borrower buying a residence where construction has progressed beyond ground works. The exemption applies for borrowers who are owner-occupiers and who are residential property investors

Loans to borrowers building a new residence are exempt.

Change: The loan must be for a residence that has been completed within the previous 6 months and it must be bought from the developer. The exemption applies for borrowers who are owner-occupiers and who are residential property investors. The LVR rules do not prescribe the size of a deposit for new residences.

Previous: Loans are exempt if used for remediation after a fire, earthquake, or to bring a residence up to new building codes. The exemption applies for owner-occupiers and for residential property investors

Change: Loans are exempt if used for remediation after a fire, earthquake, to bring a residence up to new building codes, or to comply with new rental property standards (for example, insulation). The exemption applies for owner-occupiers and for residential property investors

Unchanged: Low-deposit borrowers using the Housing NZ Welcome Home Loan scheme to buy their first home are exempt from the LVR rules.

Links:
Loan:valuation ratio restrictions
Summary of submissions & responses

Attribution: Bank release.

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Changes to LVR restrictions deferred a month

The Reserve Bank said on Friday it was deferring the start of the proposed changes to investor loan:value restrictions (LVRs) nationwide from 1 September to 1 October, based on feedback from banks.

Deputy governor Grant Spencer said: “Banks have indicated through their submissions that more time is required to enable them to meet the new restrictions that apply to investor loans nationwide, given the pipeline of loan pre-approvals made prior to our announcement in July.

“We understand that banks have been applying the new LVR restrictions to new loan applications since the LVR changes were announced. On that basis we will defer the formal introduction of the changes to 1 October in order to accommodate the backlog of pre-approvals.”

Mr Spencer said there had been a number of queries related to exemptions, and said the range of existing exemptions to LVR restrictions would continue to apply under the proposed changes. These exemptions permit the banks to make high LVR loans that would otherwise be limited by the restrictions. Exemptions apply where:

  • Owner-occupiers or investors are constructing or buying a new dwelling (provided the loan commitment occurs before, or at an early stage of, construction)
  • Owner-occupiers or investors require bridging finance to complete the purchase of a residential property on a date before the completion of a sale of another property
  • Owner-occupiers or investors are refinancing an existing high LVR loan, or shifting an existing high LVR loan from one property to another (provided the total value of the new loan does not increase)
  • Owner-occupiers or investors are borrowing to fund extensive repairs or remediation that is not routine or deferred maintenance; this includes events such as a fire, natural disaster, weather tightness issues or seismic strengthening
  • A loan is made under Housing NZ’s mortgage insurance scheme, including the Welcome Home Loans scheme
  • Borrowers with owner-occupied & investor collateral can use the combined collateral exemption to obtain finance up to 60% of the value of the investment properties and 80% on their owner-occupied property.

Mr Spencer emphasised that these exemptions didn’t create an obligation on banks to make such loans: “The banks will still apply their own lending criteria to individual borrowers and may choose to not provide finance in these circumstances or to provide it only at lower LVRs.”

He said the Reserve Bank was still analysing submissions, which closed last Wednesday, and further adjustments to the proposals, including the exemptions, were still possible. The bank expects to publish a final policy position this month.

Under the proposed new restrictions:

  • No more than 5% of bank lending to residential property investors would be permitted with an LVR over 60% (ie, a deposit under 40%)
  • No more than 10% of lending to owner-occupiers would be permitted with an LVR over 80% (ie, a deposit under 20%)
  • Loans that are exempt from the existing LVR restrictions, including loans to construct new dwellings, would continue to be exempt.

Attribution: Bank release.

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Wheeler makes 25-point cut & warns of more

The Reserve Bank reduced the official cashrate by 25 basis points to 2% today, and warned of further cuts. Its previous cut, also by 25 points, was in March.

The primary concern is that inflation isn’t rising. The bank has an abundance of inflation in the housing sector, in large part caused by its own decisions, but that’s a piece of inflation not entered in the official count.

Bank governor Graeme Wheeler said on today’s decision:

“Global growth is below trend despite being supported by unprecedented levels of monetary stimulus. Significant surplus capacity remains across many economies and, along with low commodity prices, is suppressing global inflation. Some central banks have eased policy further since the June monetary policy statement, and long-term interest rates are at record lows. The prospects for global growth & commodity prices remain uncertain. Political risks are also heightened.

“Weak global conditions & low interest rates relative to New Zealand are placing upward pressure on the $NZ exchange rate. The trade-weighted exchange rate is significantly higher than assumed in the June statement. The high exchange rate is adding further pressure to the export & import-competing sectors and, together with low global inflation, is causing negative inflation in the tradables sector. This makes it difficult for the bank to meet its inflation objective. A decline in the exchange rate is needed.

“Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism & accommodative monetary policy. However, low dairy prices are depressing incomes in the dairy sector and reducing farm spending & investment. High net immigration is supporting strong growth in labour supply and limiting wage pressure.

“House price inflation remains excessive and has become more broad-based across the regions, adding to concerns about financial stability. The bank is consulting on stronger macro-prudential measures that should help to mitigate financial system risks arising from the rapid escalation in house prices.

“Headline inflation is being held below the target band by continuing negative tradables inflation. Annual CPI inflation is expected to weaken in the September quarter, reflecting lower fuel prices & cuts in ACC levies. Annual inflation is expected to rise from the December quarter, reflecting the policy stimulus to date, the strength of the domestic economy, reduced drag from tradables inflation and rising non-tradables inflation. Although long-term inflation expectations are well anchored at 2%, the sustained weakness in headline inflation risks further declines in inflation expectations.

“Monetary policy will continue to be accommodative. Our current projections & assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range. We will continue to watch closely the emerging economic data.”

Link:
Monetary policy statement

Earlier stories:
22 July 2016: Reserve Bank governor sets off on wrong premise
8 July 2016: Housing: Alexander tips the direction, Spencer talks cautious measures, Church warns of investment flurry
10 June 2016: Reserve Bank leaves cashrate unchanged and suggests no action
10 March 2016: Cashrate cut to 2.25%
4 February 2016: A central banker’s view of stimulus

Attribution: Bank release.

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Reserve Bank governor sets off on wrong premise

The Reserve Bank released an economic update yesterday which began on what can only be a wrong premise: “Prospects for growth in the global economy have diminished despite very stimulatory monetary policy & low oil prices.”

The word shouldn’t be ‘despite’ but ‘because of’.

Independent economist Rodney Dickens said the economic update laid the groundwork for an official cashrate cut on 11 August, and labelled it “a misguided propaganda statement”.

Continuing my view that Reserve Bank governor Graeme Wheeler [correcting the original, where I promoted deputy governor Grant Spencer] is basing policy on a wrong premise:

The chosen way out of the global financial crisis was to throw money at the people who instigated the problem, US bankers. The aim was to stimulate. But have you ever heard of stimulation lasting the best part of a decade (my start point is that the wind down began toward the end of 2007, not when everybody noticed it in 2008)?

Stimulation is a misnomer in any case. It was actually about bringing forward activity that would have occurred several years later. When you do that, there still has to be a cyclical lull, eventually.

And, into the mix, the word ‘cycle’ got lost. Out of the tech boom of the early 2000s and into the housing boom that followed in the US, central bankers got the idea that they could prevent a downturn in the cycle with a little manipulation.

Less manipulation, more natural would have got the world through the worst of that global crisis. ‘More natural’ would have included some austerity – but, again, not austerity that lasts a decade.

Now that the quantitative easing has been well & truly overdone, and austerity has also been overdone in some places, trade cycles are out of kilter. It will be a slow journey back to a norm.

New Zealand’s Reserve Bank remains concerned that the $NZ is overvalued. It has also been trying valiantly, but in vain, to encourage participants in the housing market to behave less enthusiastically – as in encouraging investors not to chase obvious windfall gains while nobody has taken the trouble to change the rules to prevent those gains arising.

In a market economy, the currency is in play, assets are in play, the record net migrant inflow (now over 69,000 for the last year) adds to the pressure for asset values to rise, and the requirement for Auckland to set consistent rules for property development over the whole region has meant a process has coincided, albeit taking much less time than it has historically.

For every currency that’s overvalued, another is undervalued. Unfortunately for New Zealand, there are other nations which can swing the valuation where they want it rather than where we want it. They win. There are also nations which argue about this & get offside with each other, as in China & the US at the moment. Not to so long ago, numerous Americans were slagging China for manipulating its currency, which is loosely tied to the greenback.

Overnight, I read (Jim Rickards in Agora Financial’s 5-minute forecast) how hawkish US Federal Reserve talk about this being a good time to raise interest rates had pushed the $US higher, thus taking China’s yuan upward too. Mr Rickards says a deal hatched outside the G20 meeting in Shanghai in February meant the euro & yen would strengthen, greenback would fall and yuan would stay put. But the Fed started talking up the $US in May, the Chinese felt double-crossed and began looking at a third devaluation following 2 last year.

Now, the US is also trying to pressure China into accepting the ruling of an international tribunal on the South China Sea, and China has raised a US-promoted push to question cheap sales of Chinese steel. Thus currency, political positions & trade interact, and New Zealand is not in a position to control any of that.

It’s proved impossible for the Reserve Bank to use one tool to deal with all economic events, so it should have been using separate tools for housing & exports. The bank has tried to wend a way between being kind to exporters and encouraging housebuyers, but low interest rates have helped raise house prices and haven’t held the exchange rate down, so the bank’s appeased neither of its main target groups. In neither case is the low level of CPI inflation an issue, yet it remains a central focus of the bank.

Wheeler’s view

In his release yesterday, Mr Wheeler said: “Significant downside risks remain. Financial market volatility increased following the UK referendum and long-term interest rates have fallen.

“Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism & accommodative monetary policy. However, low dairy prices are depressing incomes in the dairy sector and weighing on farm spending & investment.

“There continue to be many uncertainties around the outlook. Internationally, these relate to the prospects for global growth & commodity prices, the fragility of global financial markets and political risks. Domestic uncertainties relate to inflation expectations & the potential for continued high net immigration, ongoing pressures in the housing market and the high $NZ exchange rate.

“The trade-weighted exchange rate is 6% higher than assumed in the June Statement, and is notably higher than in the alternative scenario presented in that Statement. The high exchange rate is adding further pressure to the dairy & manufacturing sectors and, together with weak global inflation, is holding down tradable goods inflation. This makes it difficult for the bank to meet its inflation objective. A decline in the exchange rate is needed.

“House price inflation remains excessive and has become more broad-based across the regions, adding to concerns about financial stability. The bank is currently consulting on stronger macro-prudential measures aimed at mitigating risks to financial stability from the current boom in house prices.

“Annual CPI inflation was 0.4% in the year to June 2016. Headline inflation is being held below the target band by continuing negative tradables inflation. Long-term inflation expectations are well anchored at 2%, but short-term inflation expectations remain low.

“Despite rising capacity pressures and some recent increase in fuel prices, the stronger exchange rate implies that the outlook for inflation has weakened since the June Statement.

“Monetary policy will continue to be accommodative. At this stage it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging economic data.”

Dickens: Reserve Bank committed to driving another boom-bust cycle

Independent economist Rodney Dickens, who runs Strategic Risk Analysis Ltd, said the economic update laid the groundwork for an official cashrate cut on 11 August, and labelled it “a misguided propaganda statement”.

He seized on the comment at the end of the statement and argued against the sense of it. That sentence: “At this stage it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range.”

Mr Dickens commented: “To me, the ‘economic update’ is no more than a propaganda exercise aimed at trying to talk the exchange rate down in line with Governor Wheeler’s longstanding crusade. My last Raving highlighted that the official cashrate cuts since July 2015 have been followed by a higher, not lower, exchange rate and that the forex market is smarter than the Reserve Bank.

“The Reserve Bank is, unfortunately, repeating past mistakes. Lower interest rates in 1993 & 2003 were followed by an appreciating, not depreciating, exchange rate. But today’s statement by the Reserve Bank should ring more warning bells than just the risk excessive official cashrate cuts will drive the exchange rate higher, not lower.

“The ‘economic update’ had a lopsided focus on a few issues, and especially the exchange rate, but didn’t mention once the most important issue of relevance to the medium-term inflation prospects Governor Wheeler is supposed to focus on most.  It is no more than a misguided propaganda statement…

“It included no mention of the inflationary threat developing in the labour market as a result of overly stimulatory monetary policy. This follows in the footsteps of the June monetary policy statement that severely lacked quality analysis of labour market prospects. By contrast, one of the key findings of BNZ chief economist Tony Alexander’s latest quarterly survey of businesses was: ‘Across many sectors, employers are finding it difficult to source skilled staff, especially construction & engineering.’

“The Reserve Bank is out of touch with what is happening at the coal-face of the labour market, just as was the case in the early-to-mid-2000s. Consequently, the odds are high that interest rate & exchange rate prospects are very different to what the Reserve Bank & bank economists are predicting, as was the case last decade.

“There is a real risk Governor Wheeler’s misguided monetary policy experiment, like Governor Bollard’s misguided go-for-growth experiment last decade, will result in boom-bust cycles for the economy & housing market.”

Links: Reserve Bank
Strategic Risk Analysis
Rodney’s Raving

Attribution: Bank & Dickens releases, own comment.

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Reserve Bank tilts at housing investors with 40% deposit call

The Reserve Bank released a consultation paper yesterday proposing changes to loan:value ratio (LVR) restrictions to further mitigate risks to financial stability arising from the current boom in house prices.

Bank governor Graeme Wheeler said: “The banking system is heavily exposed to the property market with residential mortgages making up 55% of banking system assets. Investor lending has been increasing rapidly and is a significant contributing factor to the current market strength. The proposed restrictions recognise the higher risks associated with such lending.”

Under the proposed new restrictions:

  • No more than 5% of bank lending to residential property investors would be permitted with an LVR of greater than 60% (ie, a deposit of less than 40%)
  • No more than 10% of lending to owner-occupiers would be permitted with an LVR of greater than 80% (ie, a deposit of less than 20%), and
  • Loans that are exempt from the existing LVR restrictions, including loans to construct new dwellings, would continue to be exempt.

Consultation concludes on 10 August and the Reserve Bank said the proposed new restrictions would take effect on 1 September. Mr Wheeler said they’d simplify the LVR policy by removing the current distinction between lending in Auckland and the rest of the country.

“The drivers of the housing market strength are complex and action is required on many fronts that extend well beyond financial policy. Broad initiatives to reduce the underlying housing sector imbalances need to remain a top priority.

“A sharp correction in house prices is a key risk to the financial system, and there are clear signs that this risk is increasing across the country. A severe fall in house prices could have major implications for the functioning of the banking system and cause long-lasting damage to households & the broader economy.

“LVR restrictions to date have improved the resilience of bank balance sheets by reducing banks’ exposure to riskier mortgages. This policy initiative is intended to further improve the resilience of bank balance sheets, and it will assist in restraining credit & housing demand.

“We expect banks to observe the spirit of the new restrictions in the lead-up to the new policy taking effect.”

Mr Wheeler said the bank was progressing its work on potential limits to high debt:income ratio lending, which would be a potential complement to LVR restrictions: “We have had positive initial discussions with the Minister of Finance on amending the memorandum of understanding on macro-prudential policy to include this instrument.”

Bulletin examines cycle risks

Separately yesterday, the Reserve Bank published an article in its Bulletin on financial stability risks from housing market cycles. It said boom & bust cycles were prevalent features of housing markets in advanced & developing economies around the world, and found that macro-prudential actions aimed at mitigating risks from housing market cycles might be justified to help preserve financial stability & long-run economic growth.

Property Institute sees political motivation

Property Institute chief executive Ashley Church promptly asked the Government to consider removing the Reserve Bank’s ability to influence housing policy in light of what he described as “a politically motivated response to house price inflation”.

He said the announcement was directionless and smacked of political expediency: “This is essentially a u-turn. 2 weeks ago we were told that these measures would be introduced ‘at the end of the year’. Now they’re suddenly sufficiently serious that they need to be introduced in 6 weeks’ time? What’s changed? Could it be that last week’s serve from the prime minister has spurred the Reserve Bank into action?”

Mr Church said the announcement would make little difference to house price inflation: “Many investors will already have close to, or over, 40% equity and this will be little more than a slight speed bump.”

Links: Reserve Bank consultation paper

Bulletin article: Financial stability risks from housing market cycles

Attribution: Bank & institute releases.

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Housing: Alexander tips the direction, Spencer talks cautious measures, Church warns of investment flurry

BNZ chief economist Tony Alexander set out an extensive road map on housing yesterday, including courses the Reserve Bank was likely to adopt, before heading away for a fortnight’s holiday. In the evening, Reserve Bank deputy governor Grant Spencer mentioned these courses in an address to the Institute of Valuers in Wellington, notably mentioned some actions that aren’t in its hands, then feebly said: “In light of the growing risk, the Reserve Bank is closely considering measures that could be progressed in the coming months.”

Property Institute chief executive Ashley Church said Mr Spencer’s speech “will almost certainly lead to another frantic burst of investor buying which will further inflate house prices.

“Watch the house price inflation figures over the next few months. You’ll see big price increases & a surge in activity as investors compete with each other, on price, to squeeze that last property out of their equity before the higher level restrictions kick in.

“What’s worse is that it will all be to no purpose, because the evidence of the past 2 years is that the loan:value restrictions have had virtually no impact on reducing house price inflation. So we’ll get a sharp increase in prices with no economic payoff at the end.”

The Alexander take on things

Mr Alexander looked at political dissatisfaction being expressed around the world and saw a difference here: “The National government since 2008 has been particularly adept at identifying areas of societal concern like this and addressing them. It is very unlikely that they are not taking on board the lessons of what is happening offshore. Hence the near-explicit instruction from the prime minister to the Reserve Bank to take measures to rein in the high pace of house price rises. The PM’s words are shifting.

“What is about to happen then is this. While the Labour Party will announce a set of alternative housing policies, the Government will look to stamp out this bushfire of housing affordability discontent ahead of next year’s general election. It may take some time for them to develop & announce policies which the electorate will view as likely to help address the affordability problem, and they won’t seek to push prices lower. But these policies will be announced & implemented before the general election next year. Their focus will not be on boosting demand from young home buyers, which is already backed up & strong. Instead it will be on supply and on reducing the attractiveness of purchasing property for investment purposes.

“Meanwhile the Reserve Bank will strengthen loan:valuation rules and put in place a system ready to implement debt to income controls. Maybe soon, investor buyers in Auckland will need a 50% deposit, and elsewhere 30%. Watch also for implementation of a rule introduced last month in Sweden, whereby anyone borrowing at less than 50% deposit must make minimum principal repayments and not have simply an interest-only loan.

“The collective aim will be not to suddenly boost housing supply, because that is not possible. Instead it will be to change buyer expectations of future supply & therefore future prices.”

Spencer starts with non-bank influences

The Reserve Bank’s deputy governor pointed firmly to housing boom causes that weren’t in the bank’s sphere of influence, and managed to aim at one that the Government can control: stemming the net inflow of migrants.

Mr Spencer said: “Many domestic & international factors are contributing to the strength of the market. The current record low interest rates are a worldwide phenomenon linked to post-GFC caution & very low inflation in the global economy. Also driving local housing demand has been an unprecedented net migration inflow over recent years, reflecting New Zealand’s stronger economic performance relative to many other advanced economies.”

Then he moved into the safer territory of criticising councils, people’s preference for standalone housing (which Mr Spencer noted was changing) and the building industry: “While strong demand has been underpinned by low interest rates, rising credit growth & population increases, the housing supply response has been constrained by planning & consenting processes, community preferences in respect of housing density, inefficiencies in the building industry and infrastructure development constraints. The resulting housing market imbalance has been exacerbated by New Zealanders’ ongoing preference for investment in bricks & mortar over financial investments, due in part to the ready availability of credit and a tax system that favours debt funded capital gains.

“Given the complexity of factors underlying the housing situation, there is no simple policy solution. We need to tackle housing on many fronts. The key challenge in the long run is to expand housing supply to meet the growing demand. The Reserve Bank has no direct influence over supply, but can influence housing demand through the credit channel.”

Cut tax advantage & control migration?

Mr Spencer said tax & migration policy were 2 areas of control to consider further. Unlike the Property Institute’s Ashley Church, Mr Spencer believed the brightline test introduced last October for housing investors “has helped curb short-term speculative activity in the housing market. Consideration might be given to further reducing the tax advantage of investing in residential housing.”

His view on migration was at best fluffy – long-term, only a marginal effect, something to consider. My own view on migration is that, when Australia gets back on its feet as activity in its mining sector picks up in perhaps 3-5 years, New Zealand’s migrant flow could reverse quickly. In that event, New Zealand could even be left with a housing surfeit for a time.

Mr Spencer: “Like taxation of investor-owned housing, migration policy is a complex & controversial issue. However, we cannot ignore that the 160,000 net inflow of permanent & long-term migrants over the last 3 years has generated an unprecedented increase in the population and a significant boost to housing demand. Given the strong influence of departing & returning New Zealanders in the total numbers, it will never be possible to fine-tune the overall level of migration or smooth out the migration cycle. However, there may be merit in reviewing whether migration policy is securing the number & composition of skills intended. While any adjustments would operate at the margin, they could over time help to moderate the housing market imbalance.”

What role can the Reserve Bank play?

Mr Spencer said low domestic interest rates had contributed to the increasing housing demand. Under the bank’s policy targets agreement, the central focus of its monetary policy framework is the 1-3% inflation target range.

“However,” he said, “the bank must consider whether its monetary policy choices could undermine the efficiency & stability of the domestic financial system. In current circumstances, the policy targets agreement rules out actively leaning against the housing cycle using monetary policy.

“Doing so would risk driving CPI inflation below the target range over the medium term. Conversely, further reductions in the official cashrate could pose a risk to financial stability through their effect on credit growth & house prices. While the outlook for CPI inflation will ultimately determine the future path of monetary policy, the trade-off against financial stability risk needs to be carefully considered.”

Prudential policy is the Reserve Bank’s primary policy instrument for promoting financial stability, requiring banks to hold permanent capital & liquidity buffers against shocks, and additional safety requirements when there is heightened risk of an extreme housing cycle. “Such policies are relevant for the New Zealand banking system, where residential mortgages make up around 55% of banking system assets and where a large share of total housing credit is to residential investors who have a relatively high risk profile.”

Reserve Bank’s main tools

The bank’s main macro-prudential tools include loan:value ratios (LVRs), debt:income ratios (DTIs) & higher capital requirements for housing loans (capital overlays).

“These 3 instruments tackle housing cycle risk from different perspectives and can be seen as complements. The LVRs, which are already in place, help to reduce the impact of mortgage defaults on bank earnings by increasing the security coverage on housing loans. LVRs also tighten up banks’ lending conditions, potentially leading to a slowdown in credit growth & house price inflation for a period.

“Debt:income ratios have been used internationally but not yet in New Zealand. DTIs aim to improve the safety of borrowers’ balance sheets, thereby reducing the likelihood of mortgage defaults in a downturn. In particular, debt:income limits are intended to better equip borrowers to continue servicing mortgages in the face of income losses &/or increases in interest rates. DTIs, like LVRs, tighten credit conditions, resulting in some brake on credit & house price inflation.

“Capital overlays, like LVRs, improve the capacity of banks to absorb losses from mortgage defaults in a downturn. Additional capital requirements might also slow credit growth as banks adjust to higher equity funding.

“How might these macro-prudential instruments assist in the context of the current housing market imbalances?

“The original 2013 LVR restrictions (requiring a maximum 80% LVR for most mortgage borrowers) & the Auckland investor LVRs brought in last year (reducing Auckland investor LVRs to a maximum of 70%), have had the intended effect of making bank balance sheets more resilient to a potential housing downturn. Together with the Government’s October 2015 tax measures, the Auckland investor LVRs also helped to reduce Auckland house price inflation from its peak of 27%/year in September 2015 to 12% in May 2016.”

However, Mr Spencer said activity had spilled into other regions and the proportion of sales to investors nationally had grown from 34% in January to 39% in May: “LVRs on new investor lending have reduced significantly, but new credit commitments to investors have recently been growing about twice as fast as for the overall market. Investors have effectively used equity generated by increased valuations on their existing portfolios to raise the larger deposits needed for new acquisitions.

“The Reserve Bank has a range of policy options available. One is tighter LVRs to counter the growing influence of investor demand in Auckland & other regions, and to further bolster bank balance sheets against a housing market downturn. Given the growing housing market pressures across the country, one approach would be to adopt a single national LVR limit for investors. Given that the banks have much of the relevant systems work in place, we expect that such a measure could potentially be introduced by the end of the year.

“Another option is a new debt:income (DTI) speed limit to complement the LVR requirements by improving the resilience of household balance sheets to income or interest rate shocks. A DTI limit would make defaults less likely in a downturn. Furthermore, a DTI & LVR in combination would constrain credit growth & house price pressures on a more sustainable basis than would LVRs alone.

“A DTI would be a new instrument that would need to be agreed with the minister of finance under the memorandum of understanding on macro-prudential policy. Adoption would require more analysis & systems preparation than an extended LVR. We intend to consult with the banks on the viability of a DTI policy & data issues before making a decision on implementation.

“A third option is a housing capital overlay. The Reserve Bank has already indicated that it will be conducting a full review of bank capital requirements over the coming year. We will consider whether macro-prudential overlays have a role to play as part of that process.”

Mr Spencer said finalising the Auckland unitary plan would be an opportunity to facilitate a step up in housing supply.

“On the demand side, the key drivers are population growth & easy credit. The low cost of credit is making higher debt levels affordable, particularly for investors who can deduct interest costs from taxable income. Residential investors are accounting for an increasing share of house sales & new mortgage credit.

“The bank’s interest rate policy must have regard to financial stability concerns, but the global environment is likely to keep interest rates low for some time yet. Macro-prudential policy can assist in containing the growing risk to financial stability as the current housing market reaches new extremes. In light of the growing risk, the Reserve Bank is closely considering measures that could be progressed in the coming months.”

Links:
Spencer speech: Housing risks require a broad policy response
Tony Alexander weekly overview 7 July 2016

Attribution: Alexander newsletter, Spencer speech, Church release.

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