agriculture

For people in New Zealand who have invested in residential property with a mortgage, March 23 delivered something of a shock. Faced with house prices on average soaring a ridiculous 25% since May and by 5.2% in just February, the government has been coming under more and more pressure to do something about the housing situation in New Zealand.

It looks like they may have been hoping that they could encourage the Reserve Bank to take moves to restrain house price rises. But as the Reserve Bank Governor politely pointed out, it is not the job of the Reserve Bank to target a particular pace of house price gain.

Instead the RB aims for inflation near 2%, full employment, the avoidance of instability in the economy, interest rates, and the exchange rate, and financial stability. The financial stability goal mainly involves intense monitoring of banks, setting capital and liquidity levels, and limiting high risk lending through a variety of means.

From around September last year it looks like the banks were actually lobbying the RB behind closed doors to bring back minimum deposit requirements for home loans earlier than their planned date of May 1. Banks were seeing extremely strong growth in credit demand from investors and were starting to reinstate the Loan to Value Ratio rules which the RB stripped away for a year as one of their responses to the Covid-19 shock. 

The RB has brought those rules back and investors now require a 40% deposit compared with 30% before the nationwide lockdown from March last year. As it is, with the banks having already brought their own rules back early, it is near impossible to look at the lending data in New Zealand and conclude that banks have been engaging in risky practices.

That situation, plus the fact that the Reserve Bank wants as much stimulus as possible to offset the Covid effects, means the Finance Minister got nowhere in his request for further assistance. So, he initiated his own attempt to restrict credit flows to investors by removing the ability of investors to deduct interest costs when calculating their taxable profit from a residential property investment.

For new purchases the rule applies immediately. For existing landlords it will be brought in over four years. The change will increase property holding costs for an average investor by about $5,000 and this has caused outrage amongst property investors because no other business is denied the ability to deduct a legitimate cost.

There have been thousands of threats to sell property and raise rents aggressively, and while there is a strong spitting of the dummy element in play, there will nonetheless be a reduction in rental property supply and increase in rents. By how much however is anyone’s guess and there is one interesting aspect of the policy change. It does not apply to new builds.

That is, an investor who buys a new property retains deductibility of interest expenses. Plus the brightline test for assessing capital gains tax stays at five years whereas it has been extended to ten years for holders and buyers of existing property.

Already in my three main surveys of mortgage brokers, real estate agents, and Tony’s View readers generally, I can see evidence of investors pulling back from the market. First home buyers have also taken a step back for the moment though to a far lesser degree.

Will the tax changes cause house prices to fall? I have no problem seeing falls for some of the next six or so months given the extreme nature of recent house price rises. But the underlying trend is still likely to remain one of house prices rising long-term, though at a rate eventually averaging closer to 5% or less rather than the average 6.8% per annum gain which has been seen in NZ since 1992. 

If you want much more information on the NZ economy and housing market in particular you can sign up for my free Tony’s View weekly at www.tonyalexander.nz

One of the key drivers of the ups and downs in New Zealand’s economy is not just the sometimes highly emotive toing and froing of the housing market, but the more fundamental cyclical changes in primary export prices. As a rule, when our export prices rise the economy’s growth rate accelerates from out of the regions into the cities. Wages growth picks up, retail sales strengthen, housing eventually benefits, migration can improve, and after a while interest rates go up along with the exchange rate – which has probably already risen anyway. 

As it turns out, with the outlook for world growth lifting sharply in recent weeks, and with China displaying high demand for New Zealand’s “soft” commodities (as opposed to Australia’s “hard” commodities like coal), some of our export prices have lifted firmly. 

The important one is dairying. At the most recent fortnightly Global Dairy Trade auction the average prices measure jumped by 15% after rising 23% cumulatively from previous auctions starting in November. Prices are now 39% up from a year earlier and at their highest level in seven years.

As a result, Fonterra have lifted their forecast for this season’s payout, and this will inject many hundreds of millions of dollars into the New Zealand economy. But here is where it gets interesting. The higher payouts don’t start right away for dairy farmers. They rise with a lag. Just as the farmers will be receiving far better cash flows, so too will tourism sector operators from early next year probably be seeing a potentially strong lift in cash receipts.

At the same time, we are likely to see net migration inflows lift anew, especially as Kiwis still overseas wanting to get back come flooding in. Plus, there will be growth-supporting rises in house construction, local and central government infrastructure spending, and stronger business capital spending generally which will likely be assisted by banks becoming more willing to lend to businesses.

But along with these new sources of growth there will be some new restraints. One is highly likely to be a higher NZD pushing towards US 80 cents – because that is what tends to happen when our export prices rise. 

In addition, very soon we are likely to see bank fixed mortgage interest rates rising in response to the now well-known rises in wholesale medium- to long-term funding costs around the world – in spite of central bank promises to keep floating rate costs low.

Very few banks outside of maybe the United States fund their fixed rate lending with floating rate borrowing. This process of “riding the curve” can be very dangerous and is actively avoided by banks in New Zealand especially.

There will also be some restraint on NZ’s growth gains from Kiwis diverting their $10bn per annum worth of foreign travel spending back towards businesses offshore rather than retailers of spas and motorcycles in New Zealand.

There will also be some restraint from worsening shortages of labour along with shortages of readily developable land around all the country (except Auckland where the Unitary Plan makes intensification quite easy). 

Overall, while the improving prospects for growth probably won’t be enough to convince the Reserve Bank that it should raise its official cash rate from 0.25% this year, it could be a very different story for 2022. This is especially so because of one very important thing which many people probably still haven’t cottoned on to.

A year ago, central bankers made the explicit decision to target the risk of keeping interest rates too low for too long in order to guarantee economic recovery post-pandemic. They did this knowing they can easily catch up on fighting inflationary pressures when they appear by quickly raising interest rates. That is what lies in prospect for the period 2022-24 at varying speeds around the world. As that happens, we should expect some fairly high volatility in exchange rates – with an upward bias for the NZD likely this year and next given the chances that our monetary policy tightening comes before moves in other countries. 

If you want much more information on the NZ economy and housing market in particular you can sign up for my free Tony’s View weekly at www.tonyalexander.nz