House prices are over-valued, but some of the pressure on rising prices should come off as more homes are built in the coming year, according to the Reserve Bank.
In its Financial Stability Report out today, new Reserve Bank governor Graeme Wheeler pointed out that that household debts levels remained high. So borrowers were vulnerable to a "potential" fall in house prices, despite cutting debt levels in recent years.
Wheeler pointed out that Auckland house prices had risen 10 per cent in the past year. And banks were lending more with lower levels of deposit than in the past especially for first home owners. However, total lending to the household sector was still not growing "especially rapidly" he said.
While the central bank would not put a figure on how over-valued the housing market was, Wheeler said housing affordability had worsened significantly since the 1990s.
Between 2001 and 2007, New Zealand had the most rapid rise in house prices in the OECD. House prices rose to five times the average household disposable income in 2007, but has since dropped back to 4.5 times, he said.
"That's quite a bit higher than the 1990s, when it was three times household disposable income," Wheeler said earlier today.
Prices could drop if people became more concerned about their high debt levels, if banks found it harder to fund home loans, or if there was a big terms of trade shock with falling export prices because of a slowdown in Asia, especially China.
The key in the housing market was to get more new homes, because "there is a supply shortage," deputy governor Grant Spencer said. That shortage would not be solved by throwing more bank loans at people to push prices up even more.
"The more that happens, the greater the risk is you could have a greater correction [fall] of house prices," in future, he said.
The bank was expecting house building to increase "substantially in the next couple of years" and there were already signs of that in rising building consents. Most of that was in Canterbury, with a pick up in Auckland responding to high prices there.
"That's a positive thing in re-balancing the market," Spencer said, adding that the rate of house price increase should "moderate" or level off, rather than fall.
The central bank would be concerned if the recent trend of declining debt levels stopped and started to go up again.
Wheeler said while there were controls on home loan-to-value ratios for banks in some countries overseas, it was not something they would want to do now, even if they had the power. The bank would have to see a systemic risk in the banking system before it would consider such controls on how much a bank could lend as a percentage of a house price.
Meanwhile, in its regular report on the banking sector the Reserve Bank said New Zealand's financial system is getting stronger, despite a challenging international environment.
The banks were "in pretty good shape" the central bank said after building their cash and capital buffers and improving their ability to cope with any stresses in borrowing markets or "credit quality".
Households and firms had generally continued to reduce their reliance on debt this year, though household debt remained relatively high, "with many borrowers still vulnerable, especially to any correction in house prices" Wheeler said.
The November Financial Stability Report was seen by bank economists as generally more positive than the previous report in May.
However, the report also said that banks generally appeared keen to increase lending, especially in sectors they thought were doing well.
Terms and conditions for home loans seemed to have been relaxed "somewhat" in the past year, after loans got tougher around 2009. Banks were now willing to lend a greater value of the home price, leaving borrowers to find a smaller deposit. Those high loan-to-value ratio loans were now starting to make up "a significantly larger share of new mortgage lending than has been the case for most of the period since the financial crisis" hit.
The relaxation of lending standards partly reflected weak loan demand, the report said.
Loan growth in the past couple of years has been broadly matched by deposit growth, so that banks had not had to borrow more overseas on wholesale markets.
However, with households still relatively highly indebted and house prices remaining "over-valued" on some measures, banks would need to remain alert to the risks of a big leap forward in credit growth in the household sector, the central bank warned.
If demand for more loans was to rise significantly and banks were willing to lend, household debt relative to income could start moving back up, "eroding households' resilience to shocks" the bank report said.
High debt levels in parts of the farming sector, such as dairying, left that sector exposed to any fall in export prices, the report said.
Releasing his first six-monthly Financial Stability Report Wheeler said the global economy was still weak and that was affecting emerging markets, including China. The Euro zone was still fragile and global growth could be further undermined by the chances of much greater government belt-tightening in the United States.
"This external environment poses significant risks for the New Zealand financial system," he said.