Housing market pressures and the exchange rate are important variables on which the pace and timing of interest rate hikes will depend, Reserve Bank of New Zealand’s Deputy Governor Grant Spencer said Friday.
“We’ve started raising the Official Cash Rate, with the aim of forestalling general inflation pressures in the broader economy,” Spencer said in a speech prepared for delivery in Auckland, on New Zealand’s housing market. “Floating mortgage rates could be 7% to 8% in two years’ time, closer to their average of the past 20 years.”
But, he said, “The extent and timing of interest rate increases will depend on a number of uncertain variables, in particular the exchange rate and housing market pressures.”
Since March, the RBNZ has raised the OCR twice by 25 basis points each to 3.00% now.
“A big uncertainty is the future path of the exchange rate, which has a major bearing on traded goods prices and overall economic activity,” he said. “The more downward pressure that the exchange rate exerts on prices and activity, the less pressure will need to be exerted by interest rates.”
Floating mortgage rates of the main banks are around 6.25% currently, so a rise to 7% to 8% in two years’ time would mean RBNZ could deliver 75 to 175 basis points of rate increases over the next two years, assuming banks continue to pass on the equivalent of RBNZ hike each time.
Spencer said the restrictions on high loan-to-vale (LVR) loans are having the desired impact, but to start easing them the RBNZ needs more confidence that the housing market is responding to rate hikes, and more importantly, that immigration pressures won’t cause a resurgence of house price increases.
“It will take some time to gain this assurance. At this stage we consider the earliest date for beginning to remove LVRs is likely to be late in the year,” Spencer said.
The RBNZ introduced LVR restrictions in October with the aim of reducing the systemic risk arising from increasingly overvalued house prices. Banks are required to restrict new residential home loans at LVRs of over 80% to no more than 10% of the dollar value of their new residential mortgage lending.
Spencer said the LVR policy has made the market less vulnerable to the effects of an adverse shock and banks are now less exposed to potential credit losses as the interest rate cycle turns upwards.
But there are still a significant volume of high LVR loans on bank balance sheets (around 20%) and as debt service ratios increase substantially over the coming two years, there could be some stress on highly-leveraged borrowers and their lending institutions, he said.
From the monetary policy perspective, Spencer said the RBNZ has two concerns on inflation: one that construction cost pressures could push up general inflation and second from rising house prices feeding into overall demand through increased household spending.
The RBNZ’s OCR hikes since March are aimed at dealing with emerging inflation pressures but the key is how much it moderates housing related pressures, he said.