A bust in Auckland property market could cause widespread economic weakness: NZIER.
Auckland's "frothy" housing market poses the biggest risk to the economy's strengthening recovery, the Institute of Economic Research says.
Its latest quarterly forecasts have economic growth picking up from 2.3 per cent this year to 2.9 per cent in 2014, which is close to the consensus among economic forecasters and the outlook in this month's Budget.
The underlying pace of recovery is gradual and boosted by one-offs: the rebuild of Canterbury and rapid borrowing and house price inflation in Auckland, NZIER principal economist Shamubeel Eaqub said.
A bust in the Auckland property market, triggered by some shock at a time when household debt levels are high relative to incomes, could cause widespread economic weakness, as well as stress for the banking system, Eaqub says.
"Last year both rents and house prices were increasing, consistent with a physical shortage of housing. But in recent months rents have stabilised while house prices have continued to rise rapidly."
That suggested some of the latest demand might be speculative rather than physical, he said.
NZIER estimates Auckland needs around 7500 new homes a year.
Its estimate is lower than some, partly because it is not convinced average household size will continue to fall at the rate it has in the past. The census will shed some light on that.
And while net migration flows have turned positive, reflecting a slowdown in the Australian economy, that represents fewer New Zealanders leaving rather than an upsurge in immigration - a pattern that tends to support population levels in the provinces rather than swell the number of Aucklanders.
The Auckland housing accord's target of 39,000 new homes over the next three years, if achieved, would oversupply the market and could see house prices drop, Eaqub said.
Alternatively a bubble-pricking shock could be external. The other 99.7 per cent of the world economy presents a mixed picture at best.
The Reserve Bank is worried about a resurgent Auckland housing market, rising levels of low deposit borrowing and the concomitant risks to the financial system and the economy.
But with the recovery still gradual and patchy, and inflation low, higher interest rates are not yet warranted and could drive the New Zealand dollar higher.
In addition, raising short-term interest rates might have little impact as longer-term debt, which is more influenced by international rates, would stay cheap because of aggressively loose monetary policy in most advanced economies, Eaqub said.
As the 2000s had shown it is not easy for New Zealand to swim against the global monetary tide.
"Interest rates are a blunt tool for a localised problem like the latest housing boom in Auckland. The Reserve Bank is more likely to use macro-prudential tools to curb the supply of credit and increase its cost."
They include quantitative restrictions on low-deposit lending, a counter-cyclical capital buffer and adjustments to sectoral capital requirements.
But these are measures to reduce financial system risk, rather than manage the economic cycle per se, Eaqub said, and their efficacy is untested in the New Zealand economy.