The Reserve Bank is warning that escalating house prices are placing risks on the New Zealand financial system.
Reserve Bank governor Grant Spencer said in a speech the housing market was important to New Zealanders from an economic, financial and emotional perspective.
It was also highly relevant to the Reserve Bank's monetary and financial stability processes.
Avoiding another costly housing boom was critical for economic and financial stability, particularly at a time when the economy faced barriers from an overvalued exchange rate, Mr Spencer said.
On average, the gearing of New Zealand households was relatively low, but a growing number of households had high levels of debt, with interest payments consuming a large portion of their income. As well as leaving households vulnerable, that could also put pressure on banks' balance sheets.
Easy credit conditions and rising house prices had prompted more people to buy homes and with construction still at a slow pace, that had contributed to excess demand and added house price pressures, Mr Spencer said.
''We are left with concerns that the current escalation of house prices is increasing risk in New Zealand's financial system by increasing both the probability and potential effect of a significant downward house price adjustment that could result from a future economic or financial shock,'' he said.
BNZ head of research Stephen Toplis said there was much talk as to whether the Reserve Bank would use prudential policy tools in a bid to curb an overheating housing market.
''This debate is warranted, as it appears odds-on that house price inflation will stay lofty, encouraging domestic demand at a time when the rest of the economy remains under duress.''
The average house price in New Zealand was 6.9 times the average gross annual wage. That was down from the peak of 7.6 times in 2007 but was still well above the average of 5.4 times, he said.
In the United States, the current equivalent ratio was just 4.1 times.
There were some extenuating circumstances. Ongoing low interest rates made debt servicing in New Zealand less problematic. Also, the New Zealand economy looked in better health than those of countries such as the US, so some premium for New Zealand assets might be expected.
''But, when push comes to shove, it's hard to conclude anything other than house prices are indeed 'overvalued'.''
If the housing market was seen to be getting out of control, Mr Toplis believed the Reserve Bank would have no option but to raise its official cash rate, even in the event that complimentary prudential policy was enacted.
BNZ economists believed house price inflation was likely to prove problematic, sooner rather than later, which in part was why they forecast the cash rate moving higher from early next year towards a new neutral of 4.5%.
However, the problem was that monetary policy, and prudential policy to an extent, was designed to influence demand.
With supply the more likely issue in New Zealand, it was likely that fiscal and regulatory policy might prove a more effective solution to the issues the sector confronted, Mr Toplis said.
To the extent that demand was funded either out of free cashflow of New Zealanders who had been saving, or by the accumulated wealth of foreign buyers, demand-constraining policy might have little impact.
Conclusions
• There is excess demand for New Zealand housing.
• It is largely a supply problem but is being exacerbated by very low interest rates.
• The Reserve Bank will be forced into addressing the demand side with higher cash rates and possible lower loan-to-value ratios.
• Houses are probably overvalued.
• A significant correction is warranted.
• Correction will not happen until there is a significant increase in the existing housing stock.
• There is little chance of a correction big enough to undermine the banking sector in the foreseeable future.
