RBNZ says sharp house price correction remains a ‘plausible outcome’

A sharp correction in house prices remains a “plausible outcome” that would have broad economic implications, according to the Reserve Bank.

The comment comes in the latest RBNZ biannual Financial Stability Report released on Wednesday.

The bank says that in New Zealand property prices have been falling since November, “but still remain high above their sustainable level”. It states that a “steady adjustment of prices towards more sustainable levels based on fundamental supply and demand factors remains desirable for the stability of the financial system”.

“…While a gradual decline in house prices to more sustainable levels is desirable from a financial stability perspective, a sharp correction remains a plausible outcome that would have broad economic implications,” the statement said. RBNZ.

“Recent buyers with limited capital are particularly vulnerable to falling house prices.

“Furthermore, a sharp decline in house prices would significantly reduce housing wealth and could lead to a contraction in consumer spending, especially when combined with reduced discretionary spending by borrowers due to rising interest rates. interest and rising cost of living.

“Debt service charges will increase significantly as current fixed rate mortgage rates are revised over the coming year.

“Some recent mortgage borrowers are vulnerable and may have difficulty repaying their debts, but overall the threat to the financial system is limited.

“Banks have kept test interest rates in their service condition assessments around 6% during the pandemic, which remains higher than current mortgage rates. This provides reassurance that buffers are in place to ensure continued debt service.”

The RBNZ says the risk of debt-service stress or negative equity is low for most mortgage borrowers, as banks have generally maintained the test rates at which they assess loan repayment capacity well above. above the actual rates at which the borrowers contracted.

“This provides assurance that sufficient reserves are in place as the stock of loans is re-priced against the mortgage rates currently offered in the market.

“However, recent borrowers with high levels of debt relative to their income would incur significant debt service costs if mortgage rates were to exceed these test rates.

“While we do not expect acute servicing stress to arise among a significant proportion of mortgage borrowers, rising debt servicing costs as monetary policy tightens should lead to a slowdown in discretionary consumption. Household.”

The RBNZ says that as house prices have started to fall in recent months, it has continued to monitor the extent of negative equity mortgages.

“Compared to December 2021 prices, we estimate that a 30% decline in house prices could cause around 10% of outstanding mortgage debt to fall into negative equity (that’s i.e. the value of the borrower’s property is less than the amount of the outstanding mortgage).

“LVR [loan to value] have acted to limit the risks of future negative equity for recent borrowers, while past borrowers have seen significant equity gains as prices have risen in recent years. Given the sharp increase in prices over the past two years, it would take a substantial decline in prices to see widespread negative equity.”

The RBNZ has worked on the issue of debt to income ratios and has recently posted their answer to a period of public tenders.

“We believe that DTI limits are an important additional tool to reduce financial stability risks and support house price sustainability, and would fill a gap that is not covered by existing regulations. We plan to finalize framework by the end of 2022, so that restrictions can be introduced by mid-2023 if necessary,” RBNZ Deputy Governor Christian Hawkesby said recently.

In Wednesday’s FSR statement, the RBNZ said banks’ test interest rates had started to rise in line with mortgage rates, “and we expect high DTI lending to slow in the coming months.”

“New CCCFA regulations, changes to the tax treatment of investment properties and tighter LVR restrictions for homeowners are also impacting the availability of mortgage credit, so we see no urgency to impose an interim test rate floor at this stage, but we are monitoring the situation closely and are not ruling out this option if there is a resurgence of subprime lending in the housing market.”

Here is the statement the RBNZ released with the report:

New Zealand’s financial system remains robust amid significant global economic challenges, Governor Adrian Orr said in the release of the May 2022 Financial Stability Report.

Globally, the COVID-19 pandemic continues to pose complex economic and financial challenges. Continued disruptions to production and supply chains, such as those currently seen in China, are undermining business confidence and increasing input costs. At the same time, restrictions on international travel and associated uncertainty are contributing to labor shortages and limiting production.

“Russia’s invasion of Ukraine has compounded these challenges, including the significant human impact. Trade flows are severely disrupted by economic sanctions and logistical problems. With Russia and Ukraine being major global producers of energy and food, this conflict has driven up global commodity prices,” Orr said.

Rising commodity prices and supply disruptions pushed global inflation above central bank target ranges, causing global monetary conditions to tighten and long-term interest rates to rise.

“The combination of a global pandemic and war is a significant challenge, but we are confident that the New Zealand financial system is resilient to a range of potential outcomes,” Mr Orr said.

In New Zealand, the reopening of borders and the easing of restrictions related to COVID-19 will have a positive impact on the tourism and hospitality sectors. However, many businesses will be tested when the broad COVID-19 tax support ends. Targeted fiscal support remains for the most affected households and businesses.

Globally, and here in New Zealand, asset prices are moving away from their highs as investors have upgraded their outlook for longer-term interest rates. In New Zealand, house prices have been falling since November, but still remain high above their sustainable level.

Banks and insurers are in a strong position to support the economy and provide the financial services we all rely on. Banks remain profitable and well capitalized, with the latter complying with our requirements. The banking system is well funded and well positioned to sustain lending in the face of a downturn, Deputy Governor Christian Hawkesby said.

“Our actions preserve continued economic and financial stability. By raising the official exchange rate and signaling further tightening to come, the Monetary Policy Committee acted to avoid rising inflation expectations and minimize unnecessary volatility in output, interest rates and the changes in the future. Our loan-to-value ratio requirements for mortgages have also limited the accumulation of highly leveraged loans, bolstering economic and financial resilience,” Hawkesby said.

“We are working with the industry and the Council of Financial Regulators on governance, risk management, capital and liquidity. By strengthening our supervisory and legislative frameworks, we are investing in our own skills and capacities. We complement our macroprudential toolkit by designing a framework of debt-to-income ratio restrictions for future use if needed. In addition, we continue to work with government and industry on longer-term challenges such as financial inclusion, climate change and understanding housing supply constraints,” Mr Hawkesby said.

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