Housing markets in some parts of the world appear vulnerable to “even a modest increase” in interest rates, and New Zealand is the focus of new research by independent global economics researcher Capital Economics.
Vicky Redwood, principal economic adviser at Capital Economics, says housing markets “are the weak link” when it comes to the impact of tighter monetary policy.
“A modest increase in interest rates could only cause price declines in a few obvious candidates. But rates may need to rise only slightly more than we expect to cause more widespread declines. While this would not trigger a second crisis global financial situation, it will continue to weigh on economic growth in the affected countries and could cause interest rates to start falling again in some places.
“…Housing markets in some areas appear vulnerable to even a modest increase in interest rates; we are most concerned about Canada, Australia, New Zealand and Hong Kong. And there is a risk that interest rates will need to rise for above its balance to control inflation. In that case, we could be seeing more general declines in prices.”
Indeed, Australia New Zealand Capital economist Ben Udy said in early January 2022 that he thought falling New Zealand house prices would prompt the Reserve Bank (RBNZ) to start LOWERING rates. interest rates again starting next year.
And he sticks to that opinion.
“New Zealand’s high proportion of fixed mortgage rates will not protect the housing market from RBNZ rate hikes. In fact, we stand firm in our view that house prices will fall this year and cause the RBNZ to change course next year by cutting interest rates.”
He expects the Bank to raise rates at each meeting this year, raising the Official Cash Rate to 2.5% (it is now 1%).
“Home sales have plummeted to a level consistent with stagnant prices in a short time. If anything, the drop in home sales means home prices could start falling even sooner than our current forecast.” says Udy.
Vicky Redwood says that countries differ in the vulnerability of their economies to house price declines.
“Those most at risk would be those that have relied heavily in recent years on residential investment (especially Canada) and those where the links between house prices and consumer spending are strongest (such as New Zealand). “.
Redwood says the property “seems overvalued” in some countries.
“For housing markets in these places, even a modest increase in interest rates may be too much.
“Chart 9 shows the relationship between house prices and income relative to its long-term average for the largest economies for which comparable data are available.
“While the balance is likely to be higher than this long-term average, those above their long-term average are more likely to be overvalued.
“Most notable is New Zealand, where the house price-to-income ratio is nearly double its long-term average,” says Redwood.
Notes that the most recent data is for the third quarter of 2021 and that the rapid increases in house prices in recent months and the decline in income as government support has been withdrawn will have further raised the ratio between house prices and incomes in the US in particular.
She says that while it’s not Capital’s “central forecast,” there is clearly “significant risk” that interest rates end up rising above their breakeven rates to control inflation.
“In that case, we would probably be seeing more widespread declines in house prices.”
She says the “good news” is that even widespread declines in property prices are unlikely to cause another global financial crisis. The rise in house prices over the past decade has not been accompanied by a prolonged easing of credit conditions. As a result, household debt as a percentage of income has remained stable and at a level much lower than that observed before the financial crisis.
“Having been buoyed by low interest rates and bond yields for more than a decade, housing markets will undoubtedly be tested as monetary policy tightens. Their performance will largely depend on how much interest rates rise and what impact the quantitative adjustment has on Financial Conditions.
“We believe that most housing markets can cope with a modest increase in interest rates. But there is still great uncertainty about how high interest rates will have to be to control inflationary pressures, an uncertainty that has only been been exacerbated by additional inflationary pressures stemming from the ongoing war in Ukraine. And property prices don’t appear to be in a good place to withstand rate increases much larger than we expect. That poses a downside risk to our forecasts. of economic growth; in some countries, weakening housing markets may well be what causes interest rates to start falling again.