New Zealand housing is already overvalued by about 25 per cent and if it continues to rise may force the Reserve Bank to hike interest rates, according to the International Monetary Fund.
Property in New Zealand has become less affordable in the past two decades with the median house price at about 4 ½ times income, some 20 per cent higher than the average of the past 30 years, the IMF said in its annual report on the nation. Internal research by the Washington-based global institution suggests "overvaluation of about 25 per cent."
The IMF had previously seen New Zealand housing over-valued by between 10 per cent and 20 per cent.
Rising house prices were a primary issue for New Zealand and could "lead to an increase in debt-financed household spending which would put pressure on aggregate demand and increase the risk of an abrupt price correction." The Reserve Bank told IMF staff its flat interest rate outlook would be reviewed if a housing boom added to underlying inflation pressures.
"The current accommodative monetary policy stance is appropriate, but may need to change if house price and credit expansion begin to fuel excessive consumption spending and inflationary pressures," the IMF report said. "The RBNZ's credibility and the effective monetary transmission mechanism in New Zealand should allow for a nimble response should circumstances change."
Real Estate Institute figures this week showed the stratified median housing price index, which smoothes out peaks and troughs, rose an annual 9.8 per cent in the year ended April. Auckland's stratified housing price was up an annual 14 per cent and Christchurch's climbed 13 per cent.
The booming markets in Auckland and Christchurch, where limited supply is failing to meet growing demand, have accounted for about 92 per cent of recent gains in house sale prices, having traditionally made up about half.
That rising housing demand has seen a third of new mortgage lending at higher loan-to-value ratios, leaving the central bank uncomfortable and saying it is willing to use macro-prudential tools to limit low equity lending if it poses a "significant risk" to the country's financial stability.
The IMF raised its assessment of the potential for a sharp fall in house prices to "low to medium", from "low" previously. Such an event would have a medium to high impact on the economy by reducing household investment and increasing mortgage defaults.
New Zealand authorities told IMF staff the new tools wouldn't substitute for macro-economic and micro-prudential measures, the report said.
"They stressed their intention to use these tools judiciously, and as experience with such instruments is limited, with caution, with the primary objective of limiting the periodic build-up of system-wide risk," the report said.
The new tools could improve the central bank's "ability to guard against a loosening of bank lending standards" fuelling house price inflation, but because they are untested "there are questions about how effective they will be given possibilities of evasion and arbitrage."