Ineffective policy, unintended consequences
Later this week, the RBNZ will again review the official cash rate (OCR) which currently stands at 7.50%. Although many economists don’t expect the central bank to raise it at this time, most do expect a rise – perhaps even two – before the end of the year.
For years, the business community, and exporters in particular, have bridled at the level of the OCR, uncomfortable that its steady rise from 5.0% in March 2003 to its current level in an effort to control inflation has encouraged international ‘hot’ money to seek our high yields, and driven the NZ$ to record post-float highs.
A substantial motivating reason for the RBNZ to pursue this aspect of monetary policy has been the relentless rise in house prices. In March 2002, the median house price was $186,000 – today it is $343,500, a rise of +85% in 5 years.
This rise in value has made homeowners feel more wealthy. Residential property has been perceived as one of their best ‘investments’.
At the same time, the amount of borrowing for residential mortgages has also grown spectacularly. In March 2002 the value of all mortgages was about $70 billion – by March 2007 it had grown 100% to over $140 billion.
It is the oft-stated aim of current RBNZ monetary policy to quell this enthusiasm for investing in residential real estate. Clearly it is distorting our investment patterns, and is probably unsustainable.
Equally clearly, keeping the OCR high, or even raising it further, is not working in achieving these aims.
Because borrowing for housing is done on a fixed-rate basis, it takes at least two full years before a borrower feels the effect of interest rate rises. And then, because of the inverted yield curve for mortgages that has existed for the past 3 or 4 years, when they come to reset their rate they have the option to choose a longer-term contract (where rates are lower), minimizing the cash-impact of their new contract.
But that high and rising OCR directly affects the business prospects of exporters, an unintended outcome. Such an outcome is having a very serious effect on the sustainability of the New Zealand economy.
There is another group equally hard hit – first home buyers. Current monetary policy treats them as collateral damage. It is now virtually impossible for someone on an average income to afford a median priced house in any main center.
In March 2002, it would have taken $258.37 a week to make a mortgage payment on a median priced house, this being 45% of the take-home pay at that time of $573.01
In March 2007, it will take $516.40 a week, or 77% of take-home pay of $668.93 to afford a mortgage on a median priced house.
Clearly few first-home buyers can afford payments at that level and are choosing other strategies, including buying in more affordable regions, and/or buying in neighborhoods way below the median level – if they buy at all.
Whatever strategy they choose, the costs of a first-home mortgage is rising much faster than take-home incomes, and increasing numbers of people are being alienated from the ‘ownership society’.
However, it is not first-home buyers who are causing the monetary policy headache, just as it is not business or exporters. They are the ones paying the price of those policies.
It is existing homeowners who are the RBNZ’s target.
But to date, RBNZ policy shots have missed most this group almost entirely.
In March 2002, the average home loan was $75,325 and cost $130.79 per week. By March 2007, the average home loan had grown to only $108,350 and assuming the same payment profile and interest rate hikes all kicking in, the weekly cost of servicing that is now $203.61
This represents a maximum increase in weekly mortgage cost over five years of $72.82
Over that same period, the average take-home weekly pay has increased by $98.44 (from $570.49 to $668.93), more than enough to afford the rise in mortgage cost, with about $25 left over.
That the average mortgage amount is so far below what a new home buyer faces indicates that not many new buyers are climbing on the property ladder.
It is crystal clear that current RBNZ policy has missed its target of restraining existing homeowners by trying to raise the cost of mortgages. More OCR rises are unlikely to have a significant effect. And ‘waiting-for-the-previous-rises-to-work-through’ is not likely to achieve their desired outcome either.
To get homeowner payments significantly higher from the currently ineffective $203.61 will need something more like $250 per week – and an OCR interest rate to achieve that would be over 10%.
But we are not going to see that.
The RBNZ will continue to aim at the residential real estate market, and miss.
Exporters, business that make things, farmers, and aspiring first-home buyers will be the losers with the current RBNZ monetary policy settings, and offshore yield-focused investors will be the winners.
It seems an odd public policy outcome to us.
For more details of www.interest.co.nz's homeloan affordability index, see here >>>
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The above is just opinion, of course. You are encouraged to review the facts and form your own conclusions.
David Chaston
email: dchaston@interest.co.nz
24 April 2007
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