The only macroprudential policy the bank has undertaken so far - loan-to-value ratio restrictions introduced in late 2013 - took some pressure off the market for a while, the bank believes, but its effect has been waning.
Meanwhile, investor activity has been increasing as a share of the Auckland market, Spencer said.
And while aggregate growth in mortgage lending has been moderate, that masks rapid growth in new lending, offset by faster-than-normal repayments of existing loans as borrowers take advantage of low mortgage rates to reduce the outstanding principal.
In a speech to the Chamber of Commerce in Rotorua yesterday Spencer said the Auckland market was particularly stretched, with house price inflation now at 17 per cent per annum and median price-to-income multiples over seven.
"The increasing degree of stretch in prices means that an eventual market correction is increasingly likely to be disruptive to financial stability and the economy."
Read more:
• Property: Reserve Bank aims to cool overheated market
• Reserve Bank trying to 'stem the housing flow' - Little
• Auckland house prices surge 13 per cent
The Reserve Bank is keen to see other policymakers do all they can to boost housing supply.
But Resource Management Act reforms could take years to be felt in new supply. "The Government and the Auckland Council might therefore consider focusing their efforts on streamlining the approvals process and increasing the designated areas for high-density residential development," he said.
On the demand side Spencer renewed the bank's longstanding plea for tax policy changes to reduce the advantages property investors enjoy, particularly highly leveraged ones. "Given the extent of the issue and what is happening in Auckland it is probably time to have a fresh look at some of the tax options."
Investors are often the marginal buyers setting prices in significant parts of the housing market.
"Indicators point to an increasing presence of investors in the Auckland market and this trend is no doubt being reinforced by the expectation of high rates of return based on untaxed capital gains," Spencer said.
"While there are difficult issues and trade-offs to consider in this area, the Reserve Bank would like to see fresh consideration of possible policy measures to address the tax-preferred status of housing, especially investor related housing."
As for what the Reserve Bank can do to curb demand, raising interest rates is not an option when inflation is as low and the exchange rate as high as they are. "There is no case at present to be increasing rates on the basis of the CPI outlook," Spencer said.
"In terms of the tools we have, [macroprudential policy] is really the only area we have where we can potentially do something."
But such tools were no panacea, he said. "Their impact is inevitably smaller than the main drivers of the current housing market imbalance."
New Zealand is one of the few advanced economies not to have experienced a major house price correction in the past 45 years of the kind that threatened financial and economic stability.
"That's the worry, that people get carried away and think it is a one-way bet. It [a crash] never happens - until the first time it happens.
"The corrections we have had in the past have been relatively moderate like in 2009 when there was a 10 per cent pullback [in house prices]." But as global interest rates return to more normal levels, many mortgage borrowers could come under pressure as they are required to refinance at higher rates, Spencer warned.
"Alternatively, a downturn in the global economy and financial markets could lead to a drop in national income and rising unemployment, at the same time as foreign creditors are requiring an increase in the interest rate premium charged to New Zealand borrowers. In such circumstances, we could see the cost of credit rising at the same time that incomes and employment were under pressure."
If a drop in demand for housing came as new supply was multiplying, prices would begin to fall. "With 60 per cent of its lending in residential mortgages, the New Zealand banking system could be put under severe pressure in such scenarios."
Concerns keep rates low
Interest rates will remain low for the foreseeable future as central banks focus on financial stability rather than inflation control, says a fund manager.
Nikko Asset Management NZ's head of bonds and currency, Fergus McDonald, said rates were being kept at record lows in many parts of the world to provide support to banking systems.
"Inflation isn't driving interest rates but financial stability concerns are," he said, following Nikko's Investment Summit in Auckland this week. "While we are part way there we're not fully there and that's one of the major reasons why we think interest rates in New Zealand and globally are going to stay low for quite some time."
A local manifestation of the concerns was the Reserve Bank's loan-to-value ratios on mortgages, introduced in 2013 with the aim of cooling a hot property market, particularly in Auckland.
With inflation weak, the Reserve Bank is widely expected to keep the official cash rate on hold at the historically low level of 3.5 per cent well into next year.
While that's good news for borrowers, it is forcing deposit holders who rely on interest income to seek out other investments.
"Low interest rates have seen a flood of money into the property asset classes ... and into high dividend shares," McDonald said.
That market dynamic has been driving the values of NZX-listed stocks including Meridian Energy, Mighty River Power and Auckland Airport.
Meanwhile, economist Andrew Hunt, who also spoke at the Nikko summit, said central banks in countries whose currencies received large foreign capital in-flows, including Australia and New Zealand, were facing a conundrum around exchange rates.
"You might want to protect your real economy by talking your currency down ... but if you do it would be quite easy to lose control. "If your currency collapses ... you've just impoverished households."
