With news the Reserve Bank of New Zealand (RBNZ) raised the Official Cash Rate (OCR) for the fourth consecutive time in 2022 – reaching three percent, the highest level seen in seven years; some Kiwis are unnerved about what lies ahead.
Independent economist Cameron Bagrie says while the bulk of the central bank’s belt-tightening has already taken place, it remains committed to inflation control, and the full impact of higher mortgage lending rates may yet hit homeowners due to refix their loans.
At its latest Monetary Policy Statement (MPS), Bagrie notes the RBNZ’s projections for economic growth in 2023 are about as close to auguring a recession as they could get – without actually forecasting one.
“Supply constraints and softer demand are dampening economic growth, and we see that the growth forecast in the middle of 2023 is 0.1 percent over two quarters.
“Given a negative number is a technical recession, we are starting to both see and acknowledge cracks in the economy.”
One of the most significant factors supporting current housing market activity is Kiwis’ strong employment prospects, with wage growth for those with skills rising at a double-digit pace and unemployment near a record low of 3.3 percent.
However, Bagrie says that while this increasing wage inflation may be helping us to feel better off, it contributes to rising domestic inflation.
“Constrained supply across all areas of the economy means demand must adjust to bring the two back into balance, but we also need to see better-suited migration policies to bolster productivity,” he says.
“The unemployment rate is too low and unsustainable if we are to control inflation. The RBNZ has acknowledged that a rising unemployment rate is required if we achieve Consumer Price Index (CPI) inflation of two percent,” he says.
The RBNZ has set a target for CPI inflation to return to its two percent target by the midpoint in 2025.
Bagrie says one of the most significant statements made by the central bank in the recent MPS pointed to a potential rethink around the neutral OCR or interest rate targets.
“In discussing the possibility of raising neutral interest rates, the RBNZ says they’re rethinking whether the current rate circa two percent strikes a balance between a foot on the accelerator and the brake.
“Our neutral interest rate has a bearing on real interest rates, and we have seen both fall for the last two decades. So, if the RBNZ raises this by 50 basis points (bps), we could expect average borrowing rates would be 50bps higher on average too,” he says.
Global wholesale interest rates primarily set mortgage borrowing rates in New Zealand. As growth concerns have risen internationally, we saw fixed mortgage rates stop rising about a month ago.
But, if the RBNZ tweaks its neutral interest rate setting, we could be in for a fresh round of rate rises or rates staying higher for longer, which would pose the question of whether interest rate cuts will follow interest rate hikes – a real possibility.
Bagrie says that the current formula for housing has been higher interest rates, more supply plus muted migration and tax changes, equals a weaker housing market. But there are signs this will stabilise – and relatively quickly.
“Construction costs are up 20 percent and house prices down more than 10, which adds attractiveness for purchasers looking at existing supply.
“Inflation will provide a floor underneath the housing market, and a change of government could see the silliness of the removal of interest deductibility reversed.
“The migration lever is starting to move as the government reassesses its stricter stance on entry for imported workers by extending exemptions for median wage temporary visa holders in the construction, aged care, processing and tourism sectors.
“While this is good news for businesses struggling with capacity constraints, New Zealand had one of the highest uses of temporary migrant labour in the developed world before the pandemic – which was a key contributor to housing demand,” he says.
While access to finance remains a critical consideration for house hunters, Bagrie says recent tweaks to the rigid Credit Contracts and Consumer Finance Act (CCCFA) have lessened the burden on purchasers applying for mortgages.
He questions the continuation of the RBNZ’s Funding for Lending Program (FLP), enacted as an incentive to keep banks lending and the economy ticking over during the darkest months of the pandemic, which made accessible $28 billion in cheap funding for New Zealand’s retail banks.
“While the FLP was an effective response to the global economic shock, its continuation until December this year remains a pain point for Kiwis.
“The RBNZ has justified offsetting inflationary effects of the FLP by deploying a higher OCR, but when banks are accessing cheaper lending rates, it largely feeds into their profit margins,” he says.
With the push-pull mechanisms of the economy engaged, the overarching message from the RBNZ’s latest economic statements is ‘we’re not out of the woods yet’.
For housing, this means the days of substantial monthly value gains are well-and-truly behind us, and Kiwis will continue to adapt to a new, more measured pace of market activity.
Construction costs and capacity constraints across the building sector will continue to slow new housing supply, proving an demand for existing stock, Bagrie says.
However, the RBNZ will act swiftly to ensure any residential value growth does not significantly affect inflation.
“There are a host of reasons the residential market could continue to grow – returning migration, slowing construction and Kiwi households in a reasonable equity position,” he says.
“However, our central bank is committed to meeting its inflationary targets and has made it more evident than ever that they are willing to break a few economic bones to achieve the Monetary Policy Remit. Those with high leverage will be exposed.
“This will mean ensuring house prices do not run away again, and I expect values will continue to settle at the current pace through to 2023 with a more moderate pace of growth after that,” Bagrie says.