By Bernard Hickey
Westpac Chief Economist Dominick Stephens has warned that an extended period of low interest rates risks heating up the housing market from warm to ''positively frothy" and does nothing to redress the economic imbalances forcing New Zealand to keep borrowing heavily from the rest of the world.
Stephens forecasts in Westpac's quarterly overview the Official Cash Rate (OCR) is likely to stay at 2.5% until July 2013 and could even be cut to 1.5% if European financial markets experience 'Euro-geddon'. He expects the Reserve Bank to start increasing the OCR from July next year to 5% by March 2015. Westpac now sees a peak in the OCR of 5.5% in late 2016.
He forecasts house prices will rise 8% next year, on top of a 6.5% increase this year and up from his previous forecast for 2013 of 3% house price growth. That would imply a 15% rise in national house prices over the two years from the end of 2011 to the end of 2013.
The extended period of low interest rates was a factor driving house prices higher and the Reserve Bank risked missing a surge in inflation from the Christchurch earthquake rebuild, he said.
"The Reserve Bank is leaving interest rates low because inflation is unthreatening and the exchange rate is uncomfortably high. This situation could persist for a while, so we now expect no change in the Official Cash Rate until July 2013. But if interest rates stay low for longer, the housing market could go from warm to positively frothy and that would have a commensurate effect on consumer spending and debt levels," Stephens said.
"Although we don’t expect a replay of the self-reinforcing spiral of rising house prices, debt and spending that characterised last decade, we are concerned that New Zealand’s economic imbalances could make a comeback of some sort. As Mark Twain once said, history doesn’t repeat itself, but it does rhyme," he said.
"The most significant development in our forecasts is that we now expect the rebound in house prices to extend further – on top of a 6.5% increase this year, we expect an 8% rise next year (previously 3%). The combination of rising house prices and a long stretch of low interest rates will have a commensurate effect on consumer spending and credit growth and could lead to a growing conundrum for the RBNZ."
Stephens said the 2002 to 2007 boom period was characterised by an upward spiral in house values, household debt and consumer spending.
"That period was driven not just by lower mortgage rates but also a favourable tax treatment for highly leveraged property investment. Easy credit and a booming economy gave people the confidence to take advantage of these conditions, and household saving rates turned sharply negative," Stephens said.
But the environment after the Global Financial Crisis (GFC) was markedly different.
"Household saving rates have turned positive, and credit growth now lags behind income growth. Housing debt has grown just 1.5% in the last year, compared to the double-digit growth rates of 2003- 2007. Some of this can be attributed to ‘deleveraging’, albeit mostly of the passive kind – since mortgages have a schedule for repayment of principal, deleveraging is the default setting. There is also a portion of borrowers who have kept their repayments the same in dollar terms as interest rates have fallen, so that they are repaying principal faster (though the implication is that this will reverse once interest rates rise)."
The absence of leveraging had been a greater force as cautious consumers held back from taking on ever-higher levels of debt against the same properties, which meant the links between house values, household debt and consumer spending were more ambiguous than during the 2000s.
"However, the chain of causation from interest rates to house prices remains very much intact. This points to substantial upside to house prices if, as we expect, the subdued outlook for inflation leads to an extended period of low rates. Our forecasts imply a stabilisation or even a modest fall in the household saving rate – that is, growth in consumer spending will rise to be more in line with growth in actual and expected incomes. That’s still a sharp contrast to the rapid spending growth during the last housing boom."
Wider current account deficit and need for structural changes
Stephens said Westpac expected New Zealand's current account deficit to widen from its current 4.5% of GDP to a peak of 6.7% next year with the imported component of the Canterbury rebuild accounting for about 1 percentage point of the widening.
"While high by global standards, this would be well short of the 8.9% peak reached in the previous housing boom – and just as in the last decade, there is no indication that such a deficit will harm the appeal of the New Zealand dollar as an investment destination," he said.
"Nonetheless, it’s a stark reminder that the need for longer-term structural changes to the economy remains undimmed by the recession or the GFC. A long period of low interest rates will only work to sustain these imbalances."
(Updated with peak OCR of 5.5% and total house price inflation in 2012/13 of 15%.)
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