David Hargreaves looks at the RBNZ's challenge of taming the Auckland housing market - and wonders why it is being left to do the job

By David Hargreaves

Wow, what a difference a year makes.

It is is a little over 12 months ago that I penned a piece on this website about how people should prepare themselves for the 'mortgage storm' - as interest rates were about to rise.

Now we have the situation in which our central bank is stuck very rigidly between a wish to dampen an over-heating Auckland housing market (which it would traditionally do with increased interest rates) and the reality of a low-inflation environment and an over-valued New Zealand dollar,  with the latter likely to head for the stars again at the mere thought of higher interest rates.

But to go back a year,  rise the interest rates did, sure enough, with the Reserve Bank hiking its Official Cash Rate from an all-time low of 2.5% to 3.5% by the middle of the year. But as we now know of course the fact that inflation in this country has not picked up as was earlier thought likely, coupled with increasingly dodgy looking prospects for overseas economies - notably Europe - means that the OCR is almost certain not to rise again this year and possibly not next either.

What about the houses?

The big question mark then in all this is what happens to the Auckland housing market, which showed 15.1% price inflation last year, according to latest Real Estate Institute figures?

There seems no question that the Auckland market will continue to be heated this year, particularly when you consider that according to realestate.co.nz the inventory of houses in Auckland - that is, available houses for sale on the market, is at its lowest level since realestate.co.nz started compiling figures in 2007.

Low interest rates and a shortage of listings should only lead to one thing - and it ain't lower prices.

It is interesting to note that the OCR, which has been with us as the RBNZ's monetary policy instrument of choice since March 1999, has now been no higher than the current 3.5% since January 2009. This means that "low" interest rates have now been with us for just on six years. The outlook now is that they may be here for many more, which will continue to encourage people to buy.

Little wonder then, perhaps, given this low interest environment, that we've seen one bank, the TSB, sufficiently emboldened to go for a 10-year fixed mortgage rate.  You can see all the current mortgage rates here.

I'm betting that the TSB move sent a few shudders down the collective spine of the RBNZ. Other banks will be watching the TSB move very closely. If it looks to be gaining traction then I see no doubt that other banks will climb in with matching offers.

If such offers are readily replicated then the OCR - already, it seems, under threat as the RBNZ's weapon of choice - starts to look increasingly redundant.

Stamping on the brake

In far more basic language than the RBNZ would ever use, the main principle of the OCR was that it would control inflation by affecting household spending. If inflation was low, then the OCR was low. The low level of the OCR would be reflected in low floating mortgage rates, people would have more money available and would spend more, thus stimulating the economy.

But of course, once the economy was becoming over-stimulated and generating inflation, then the RBNZ could put the clamps on the OCR and force up the floating mortgage rates, thereby reducing the amount of money in people's pockets and taking steam out of the economy and inflation.

The effectiveness of the OCR was, however, drawn into question in the mid-2000s when the house market really started to rage. The banks were able to source cheap money from overseas, which was offered at fixed rates. Because so many people started to fix rates this meant that increases in the level of the OCR had no immediate impact. The house market continued to burn and the RBNZ was forced to keep stamping on the brake, forcing the OCR up to 8.25% by mid-2007.

Cheap money

The 2008 global financial crisis saw the end, for a time, of the cheap overseas-sourced money. In the meantime, more people in NZ switched to floating mortgages from fixed. At the end of 2012 more than 54% of mortgage financing by value was at floating rates. As of December 2014, the latest available figures, only around 27.5% of mortgage money is at floating rates - with the rest fixed.

But its is worth noting that of the total mortgages outstanding - just shy of $200 billion-worth - around a quarter by value are fixed for less than a year, with another quarter or so fixed for just one-to-two years.

Tallying everything up, over 84% of outstanding mortgage money by value is either at floating rates or fixed for only up to two years. My bet is we'll see those fixed rate figures blowing out for increasingly longer terms.

So, a TSB-type move is of real interest. And with the banks now well able to access plenty of that cheap offshore money again, you wonder how far the move to longer and longer fixed rates may go. It will be interesting to "follow the fixing" month-by-month as monitored by the RBNZ.

What this all means is that the humble OCR is looking increasingly sat on the shelf in terms of its practical usefulness. Hence we see the move by the RBNZ toward macro-prudential tools, such as the 'speed limits' on high loan to value lending that were introduced in 2013.

Stuck with LVRs

I boldly, and quite wrongly, predicted that the LVR limits might be lifted last year. I actually still think it would have been a good idea, because the point was proven. The banks were pulled into line and the policy did have a dampening effect on the housing market. Of course now the impact has weakened over time, but notwithstanding that there is no way the RBNZ could contemplate removing the LVR limits now with the Auckland market heating up again.

Therefore, I now side with those who said in the first place that the LVR limits will actually never be removed. The only way that might happen is if the RBNZ decides to replace them with something else - which of course is possible. But otherwise, for good or bad, I think we are now stuck them.

There is no doubt that within the next couple of months the RBNZ will be coming out with some more measures to stand alongside the beleaguered OCR. Various things are being bandied around as possibilities, including making banks hold more capital against loans to investors by treating those who own five properties and more as business customers and perhaps introduction of income-to-borrowing ratio limits.

I'll be having a look in more detail at some of the options in coming weeks.

Why leave it to the central bank?

But the thing that is really sticking out to me at the moment is that the problem of the overheating Auckland housing market is being left to our central bank, rather than the Government.

Now, yes, the Government is making the right noises in terms of Auckland's mooted shortage of housing, through such things as the Auckland Housing Accord, to fast-track new developments.

But this is longer term and aimed at supply.

There is still the demand issue.

RBNZ figures show that around 30% of new mortgage finance is going to property investors. So, very crudely extrapolating, perhaps around one in every three houses are being bought by investors.

That statistic has nothing to do with supply. What that is about is the blanket acceptance in New Zealand that housing is the best form of investment. For some people the only one. The concern is of course that as a nation we end up with all our proverbial eggs in the one proverbial basket.

It is extraordinary that this country does not have a capital gains tax - not from the point of view that it would raise revenue for the Government, because I don't think it would, significantly - but from the perspective of at least getting people to consider other alternatives to housing as an investment. At the moment, housing as an investment is a no-brainer because it offers all the incentives (particularly on tax) in comparison with other forms of investment, notwithstanding the fact that in theory you are liable to pay tax on profits if you are seen as someone who buys and sells for profit. But that is a woolly issue.

Successive governments - and the current one is certainly in this category - have completely backed off the housing market and taking action on it. Why? Because housing is such an ingrained part of the New Zealand psyche that any government doing unpopular things in that area is committing political suicide.

But the real point is that our politicians collectively need to develop some steel on this issue. The prosperity of the country depends on it. Otherwise our economy risks ongoing boom and bust cycles based on the ups and downs of the housing market.

This business of hiding behind the central bank really is not good enough.