Brian Fallow

The Economics Editor of the NZ Herald

Wheeler spells out home loan rationale

Reserve Bank Governor Graeme Wheeler in his office. Photo / Mark Mitchell
Reserve Bank Governor Graeme Wheeler in his office. Photo / Mark Mitchell

Governor Graeme Wheeler understands why some borrowers would be very disappointed by the Reserve Bank's decision to impose curbs on mortgage lending at low deposits.

"But I don't think first-home buyers or buyers who have low deposits are well served by a market that is in danger of getting out of control," he told the Herald.

"If house prices did decline because of a financial setback - which could happen, for example, if China's growth slowed dramatically - then the people most affected are the first-home buyers."

When an asset price bubble bursts, he said, "it imposes huge costs to individuals, to families and also to the economy".

When people find themselves with negative equity (mortgage debt that exceeds the value of the property) it can take years to recover, especially in the context of recession and a weak labour market.

New Zealand had a particularly rapid increase in house prices during the mid-2000s, pushing prices and household debt levels to very high levels relative to incomes.

That boom was not followed by a bust, of the kind experienced in the United States, Ireland and Spain.

But it was followed by a dearth of new building, the lowest mortgage rates in 45 years and more recently by a turnaround in net migration flows, which have combined to fuel a fresh outbreak of house price inflation.

Wheeler welcomes moves to boost the supply side of the housing market.

"The risk in places like Auckland is that getting supply [and demand] back into reasonable balance, in terms of the release of sections and dealing with some of the cost and productivity issues around the house construction sector, could take quite some time and house prices would just continue to rise very rapidly," he said.

"We could have done what many other countries have done and just had a moratorium and just said that nobody, unless they have a deposit of a certain size relative to their loan, can get access to housing finance. We just thought that was far too draconian and didn't want to go there."

Instead the bank has opted for a "speed limit" restricting lending at loan-to-value ratios (LVRs) of more than 80 per cent to 10 per cent of new lending. Exemptions, chiefly where the state guarantees the loan, add another 5 per cent. The policy should more than halve high LVR loans as a share of new lending.

The Reserve Bank estimates that its LVR curbs will reduce housing market turnover by between 5 and 10 per cent compared with what it would otherwise be, and shave between 1 and 4 percentage points off the rate of house price inflation.

But there are offsetting influences, including a rapid increase in the net inflow of migrants - mainly the result of fewer New Zealanders leaving for Australia and more expatriates returning.

The net gain was 15,000 in the year to September, a turnaround from a net outflow of 4000 the year before.

Westpac's economists estimate that a net inflow of an extra 10,000 people is associated with an extra 3 percentage points of house price inflation.

The Reserve Bank is sceptical of claims that its restrictions on high LVR lending is having a perverse chilling effect on house construction and that new builds should be exempted.

"We are talking to the banks and getting some data," he said, "but we don't believe at this stage that the LVRs are a major impediment for new building.

The demand for housing is still quite strong and we are also finding that the costs of building a new home compare favourably with the cost of existing homes in many parts of the country," he said.

"As with any regulation as soon as you start building in more exemptions you create risks of avoidance and unintended consequences."

While the risk an overheated housing market poses to financial stability is the primary reason for the LVR policy, the bank is also wary of house price inflation spilling over into general consumer price inflation, as it did in the mid-2000s.

"We are in a very tricky situation in many respects," Wheeler said.

"As you look out you see an economy that is growing at 3 to 4 per cent in the second half of this calendar year, and it looks to be sustainable for quite a period of time.

"You see an exchange rate close to historic highs on a trade-weighted basis.

"You see a housing market that is showing signs of excessive demand in parts of the country, especially Auckland.

"And you see inflation starting to pick up, pretty well in line with what we were forecasting."

The bank's forward guidance, in the form of projections in its monetary policy statements, have for some time signalled a rise of around 200 basis points in the official cash rate starting some time next year.

"That would essentially mean mortgage rates in the order of 7 to 8 per cent," Wheeler said.

Those interest rate projections assumed an exchange rate around 4 or 5 per cent lower than it is now, he points out.

"The high exchange rate will diminish inflation pressures and that may mean, in terms of our our inflation objectives, that it gives us some degree of freedom in respect of the timing of future official cash rate increases."

Having spent years in the uppermost echelons of the World Bank, based in Washington, Wheeler is keenly aware of how exposed New Zealand is to what happens in the other 99.8 per cent of the global economy.

It would have been helpful, he said, if the US Federal Reserve had started to unwind its quantitative easing policy, under which it has been printing money to buy US Government debt at the rate of US$1 trillion a year, in September as the markets expected.

"The US dollar may well appreciate during that period and that would help us in terms of being able to tighten monetary policy and raise interest rates in 2014 with the background of a weaker New Zealand dollar, so that when we tightened we would not be facing the same exchange rate pressures and drive the New Zealand dollar even higher."

It now looked as if the Fed's "tapering" would be pushed out until March next year or possibly even later.

"Why is our exchange rate so high? Some of it is due to the terms of trade being close to historic highs. Another reason is the stronger growth New Zealand is experiencing. Another is that our policy rate at 2.5 per cent compares with 0 to 1 per cent for much of the rest of the world and the expectations are that we will tighten rates as we go into 2014."

This does not make for an environment in which intervention in the foreign exchange market would do any good. The Bank for International Settlements recently reported that turnover in New Zealand dollars in the global foreign exchange market is running at more than $100 billion a day.

It is the tenth most traded currency in a market with a daily turnover in excess of US$5 trillion.

And Federal Reserve chairman Ben Bernanke's signal last May that the beginning of the end of quantitative easing was nigh - premature though it may have been - was enough to see the currencies of two of the BRICs, India and Brazil, thrown around like rag dolls.

"These flows are just so strong that if you do intervene it is very hard to change the strength of those flows in any way," he said. "Where [intervention] can be useful is if the market has uncertainties about where the New Zealand dollar is heading and liquidity starts to dry up.

"In that situation there may be potential for the central bank to intervene and basically reduce the risk that traders see it as a one-way bet that the exchange rate will always continue to strengthen. But it is taxpayers' money so we always have to be very careful."

- NZ Herald

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