Treasury does not expect a surge in house prices as interest rates fall, since the market has already priced in the expected decline in long-term mortgage rates.
In a public lecture on Wednesday, Chief Economist Dominick Stephens said that while lower interest rates eliminate the risk of further house price declines, they shouldn’t lead to significant increases.
“I think people are thinking that since interest rates are falling now, then house prices must go up … there is a very strong relationship between interest rates and house prices, but I don't think it works quite that simply,” Stephens said.
It is not short-term changes in the Official Cash Rate that move house prices, but the long-term expectation of where those rates will settle. That is why the Treasury is forecasting “low single-digit growth” rather than a sharp rebound.
“The level of interest rates that prevailed during the peak of the Official Cash Rate, had that peak been sustained, there would have been a lot more downside in house prices. They would have fallen a lot further,” he said.
“So, when the expected drop in interest rates occurred, that eliminates the downside for the housing market. But it does not, according to our models, really suggest a huge upside”.
That said, the housing market appears to be stabilising. Prices were flat and sales were starting to pick up. Banks have reported a significant lift in new loan applications, he said.
The property market was most responsive to long-term interest rates, which had trended lower for decades and driven a generation of house price growth.
For example, the five-year swap rate was 1.3% at the end of 2019 and fell further during the pandemic. It then surged above 5% as inflation spiked but has since settled at 3.75%.
The 10-year swap rate was 1.7% before the pandemic and has traded somewhere between 4% and 5% since 2022 — it was last recorded at 4.17% on Wednesday.
Stephens said houses bought from 2022 onward were priced for long-term interest rates that the two-year swap rate has only recently approached. If that drop hadn’t happened, house prices would’ve fallen further.
"In the late 2010s and early 2020s there was a bit of euphoria around a sense that interest rates had dropped to very low levels. And perhaps some people in the market thought rates could stay at those very low levels for a long time,” he said.
That expectation has changed, and the market now believes interest rates will remain significantly above pre-pandemic levels.
“Therefore what people are willing to pay for an asset is a little bit different now to perhaps what it was at the peak of that slightly euphoric period."
Other policy considerations
Changes in residential zoning policy are another reason to think falling interest rates may not result in a lift in house prices. If land supply were unlimited, lower rates would reduce building costs and rents would fall.
Stephens said that because New Zealand’s land supply was so constrained in the decades before the pandemic, falling interest rates drove prices higher.
“The decline in interest rates needed to lead to a change in the price-to-rent ratio of houses, but it resulted in higher prices rather than lower rents because of the restricted land supply,” he said.
Stephens said his work with the Housing Technical Working Group had emphasised that land supply is the key factor in how the market responds to interest rate and tax changes.
While NZ was still on the “more constrained end” of the supply spectrum, some improvements had been made in recent years.
“There's evidence that the Auckland Unitary Plan resulted in something of a loosening over time; rent in Auckland clearly … rose less than other places in New Zealand,” he said.
Wellington recently passed its own looser zoning plan, and Housing Minister Chris Bishop has pledged to require all cities to zone for 30 years of growth—though that policy has yet to be implemented.
These looser zoning rules may further limit house price increases, as the lower cost of capital should result in more housing being built and more affordable homes for people to buy or rent.
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