BNZ chief economist Tony Alexander believes some home owners might be complacent about how far interest rates are set to rise

Some home owners are likely to be unprepared and in for a shock when interest rates start rising, BNZ chief economist Tony Alexander says.

He told interest.co.nz that because interest rates had been low in this country since late 2008 some people are likely to have become complacent.

The Reserve Bank is indicating it will be necessary to raise interest rates through the Official Cash Rate (OCR) from next year onwards to dampen emerging inflationary pressures. The central bank is suggesting that the OCR may be around 4.5% by 2016.

With average floating mortgage rates currently around 5.8%, a 2 percentage-point lift in the OCR would see mortgage rates likely lifting by about the same amount, to nearly 8%.

Alexander said it was possible floating mortgage rates might be around 6.8% by Christmas next year and he believed some people would not be prepared - simply because of how long interest rates have remained low.

"You’ve got a whole grouping of people who think maybe this is the new normal," he said.

"They see messages from overseas of growth downgrades, of central banks saying they are going to keep interest rates low for a long period of time.

"They’ve seen previous warnings - that maybe you need to get into fixed interest rates - prove not to be the best advice at times. And those who have stuck on floating will say, man, I’m just going to stay floating hereon out."

There may, therefore be  "a bit of complacency", Alexander said.

"And the thing to look for there will be as interest rates are rising, people saying: ‘They are only going to go up a little bit. The Reserve Bank isn’t going to raise them a lot and cause a recession in the New Zealand economy’

"…Yes, they will - if they think that’s what it is going to take to get inflationary pressures eventually under control. It’s not our forecast, but the risk is always on the upside over that interest rate cycle and I don’t see this time being any different."

So, did Alexander think some people might be shocked by the magnitude of the rate rises to come?

"I think there will be some shocked people who are sitting there right now assuming ‘nah, they are not going to be able to raise these rates for ages because the rest of the world is still looking relatively woeful’.

"[But] here in New Zealand we’ve got the biggest construction project in our history just getting under way at the moment. We’ve got continuing high commodity prices – a 2.3% equivalent boost to GDP from Fonterra dairy suppliers for this season for instance.

"So, a lot of positive factors that say our growth accelerates, unemployment rate comes down, wages growth accelerates, all these sort of things that add to inflation and eventually will cause concern for the Reserve Bank - not now, but 12,18, maybe 24 months down the track.”

Scope of rate rises

BNZ economists recently moved back the timing for when they expect the first hike in interest rates by the RBNZ from March to June next year. Alexander said this was mainly because of the effects of  a high Kiwi dollar. But they still believed fairly aggressive rate rises would be needed to combat future inflationary pressures.

"For now, pretty much like everyone else out there including the Reserve Bank, we forecast that the cash rate will rise about 2% [ultimately].

"The risk is it rises more than that.

"We’ve been at this point in the interest rate cycle a number of times before and what us economists tend to do is underestimate how much interest rates will rise.

"We always say ‘this time it’s different’ and by crikey, I’m saying definitely again, this time it’s different.

"So, maybe that means that the cash rate doesn’t peak at the old 6.5-8.5% area. Maybe it could peak at 5.5%.

"So, our official view is a 4.5%  peak. [But] I would run my numbers for people looking at borrowing money, assuming a 3% increase in mortgage rates - not just a 2%."

Ahead of the anticipated need for interest rate rises, the RBNZ introduced from October 1 "speed limits" on high loan-to-value lending (LVRs), which is primarily aimed at preserving financial stability, but with an eye also on taking some steam out of the housing market. See here for all articles relating to LVRs.

First home buyers abandon market

The latest BNZ-REINZ Residential Market Survey showed that the imposition of the LVR limits prompted would-be first home buyers to desert the market in droves.

"The first home buyers have basically hopped out of the market," Alexander said.

"..And it’s opened up the market for the investors, for foreign buyers – and so you still had in fact a net 6% of the agents [in the survey] saying 'we are seeing more investors in the market'."

Alexander said the negative reaction of the first home buyers was definitely stronger than he expected.

"...So that just leads me to think that there’s probably a large shock element that’s running through in the minds of these people.

"These people have never made a big financial decision like this before and so they are wary about how much maybe they can borrow etc, it’s a big decision to make."

'Running scared'

He believed, however, that a lot of the potential first-time buyers were just "running scared at the moment" and would be back into the market eventually.

"It will be reversed. It is just a matter of, we are not really sure how long it is going to take."

In terms of what he saw happening to the housing market in the next six months, Alexander said, it was "going to be a wee bit messy in terms of the indicators that we use". He then listed a number of factors that would underpin the housing market.

"I think we will start to see a return of the first home buyers, very slowly.

"I think we will definitely see a strengthening of the investor interest because that’s the pattern around the world.

"You’ve got continuing low interest rates in all countries out there.

"You’ve got central banks continuing to print money in some regards and maybe signalling further interest rate cuts across the Tasman.

"Investors are either going into equities or into property and there’s no reason for assuming we will be any different here in New Zealand, with more Chinese money - emerging economy money generally - looking for a home.

"The shortage of property continuing in New Zealand, the migration numbers into boom territory, almost, as well.”

A happy realisation

"So, I think we are going to have a lot of people realising that the market hasn’t collapsed  at all that: ‘Oh, right, this is again like late 08/09 when we are not seeing house prices fall 40% in New Zealand simply because a significant event has happened' – and that’s what this is – it’s a significant event.

"I think the data will be slightly messy but then we are going to be again basically ramping up [with the housing market] again through 2014."

Alexander therefore agreed with the proposition that there was likely to be a shock to the housing market sales figures this month, but that sales volumes and prices would pick up again next year.

“Prices go up. The fundamental for New Zealand hasn’t fundamentally changed in that there is a shortage of property.

"...In fact during the September quarter the number of consents issued for the new houses to be built in New Zealand fell by 3%. So, this supply and demand imbalance increases, it gets worse. And the first home buyers who were going to become property owners have to stay property renters for a bit longer – and that’s what the investors can see.

"So, the fundamental there is that unless something comes along and radically increases house supply in New Zealand in the near future – and nothing is going to come along – prices go up, end of story."

What sort of house price rises?

But what kind of price increase for houses in the next 12 months could we be talking about?

The RBNZ has talked about the LVRs knocking between 1 and 4 percentage points off house price inflation. If you take the mid-point of that range then it would be a 2.5 percentage point impact.

"So, if you take 2.5% off whatever was otherwise going to be the case, so, maybe you end up with a 10% capital gain in Auckland," Alexander said.

"Maybe it is going to be similar down in Christchurch as well. The rest of the country, generally – but not exclusively – it won’t be that much. It takes time for those gains in Auckland and in Christchurch to spread to other centres but generally, let’s guess something like about 10%.

"But I’ve never actually seen anybody with a model that accurately predicts house price increases. Best guess."

Alexander recently observed that the LVR limits were likely to turn more young New Zealanders into housing investors rather than owner/occupiers.

He said he recognised the sentiments of young people and recalled the feeling he had when he came back to New Zealand from overseas in 1987 and saw that house prices were rising quickly.

'You feel it in your gut'

"And you feel it in your gut, the need to get a foot on the ladder. You become fearful of missing out on buying the sort of house you want because the prices are rising so rapidly. So you need to do something basically to get yourself in there and rising along with all the other boats.

"If as a result of the new LVR rules you are not going to be able to buy the true first home that you wanted, that doesn’t mean that gut desire to get on the ladder has changed at all.

"I think you are going to be looking at something else, some other way of doing it.

"I think it is going to lead to a lot more people looking at inner city apartments in Auckland, predominantly we are talking about here, and people just looking at a lower priced property they’ve got the deposit for and they’ll rent it out as an investment.

"They’ll be hoping to make some capital gain, maybe some decent rental income and build their deposit over time though a combination of the rental income and the capital gain and then get the place that they truly want, you know 1,2,3,4,5 years or whatever down the track.

"There are no numbers on this at the moment and there will be no numbers in the future in that unlike Australia we don’t have data showing there are this many first home buyers out there and there are this many investors -  but generally I think that’s the trend we are looking at for a lot of young people."