New Zealand's flagging residential property market is set to take off again next year due to the cancellation of capital gains tax and a sharp drop in mortgage rates, says Westpac chief economist Dominick Stephens.

Stephens is picking national house price inflation will lift from two per cent currently to seven per cent next year.

"The cancellation of capital gains tax, combined with sharply lower mortgage rates, will be game changing" he says. "Lower mortgage rates reliably lead to higher house price inflation, as we have repeatedly seen over the past couple of decades."

Stephens says Westpac's previous house price forecasts incorporated an assumption that some form of capital gains tax would be introduced in 2020, causing a period of house price decline.

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"The rationale for expecting house prices to fall next year has disappeared, and we have lifted our 2020 house price forecast accordingly," he said.

Stephens described the Government's decision to reject a proposed capital gains tax as "a tragedy for the efficiency and fairness of the New Zealand economy."

"New Zealand will continue down the path of falling home ownership rates, because the lack of capital gains tax will continue to incentivise property investment and will keep house prices higher than otherwise."

There were offsetting negatives that tempered the outlook, including the foreign buyer ban and the upcoming "ringfencing" of tax losses on investment properties, he noted.

But the lower interest rate track of the Reserve Bank was going to be a big driver of the market.

"Over the years we have found that the ups and downs in mortgage rates have been a great guide to how the housing market will fare over the coming year or two," he said.

Westpac chief economist Dominick Stephens. Photo / File
Westpac chief economist Dominick Stephens. Photo / File

"A home buyer can now pay 10 per cent more for a house while still making the same interest payments on a two-year fixed mortgage. For a landlord, being able to lock
in low fixed rates means that the numbers are more likely to add up on a new investment.

And New Zealand savers who become fed up with even-lower term deposit rates
will probably cast their eye to property ownership before anything else."

Westpac forecasts that the lift in prices will be relatively short-lived, with the market slowing again as we head into the 2020s.

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"We expect construction activity to remain very high for some time, while net migration drops," Stephens said.

"In time, this will cause dwelling shortages to gradually diminish. This will put downward pressure on rents and house prices (although other factors such as interest rates and tax policy will remain more influential for house prices).

The expected alleviation of housing shortages is one reason we expect house prices to stagnate or fall later in the 2020s."