Economic Weekly: Housing market complicates RBNZ’s balancing act

The RBNZ’s job just got a lot trickier than usual.  The RBNZ has multiple jobs to juggle – it has its Monetary Policy objectives - a dual target of inflation and maximum sustainable employment.  But at the same time, it must also balance Financial Stability Risks.  Most of the time, it can juggle both responsibilities, as the various risks move together through the economic cycle so relaxing Monetary Policy settings does not conflict with the RBNZ’s Financial Stability goals.  However, there was no modern precedent for the COVID-19 pandemic, and during this highly unusual time we are all learning as we go. 

In the early days of the COVID-19 pandemic, the RBNZ was quick to grasp the seriousness of the situation and was quick to deliver policy support via slashing the OCR, putting in place a range of monetary implementation measures and introducing Quantitative Easing in NZ.  On the Financial Stability front, the RBNZ relaxed Loan to Value (LVR) lending restrictions across the board, in large part to support the housing market.  Alas, economists (including ASB) got it wrong, and the surprisingly resilient economy, plus large falls in mortgage rates, plus relaxing LVR lending restrictions proved a very potent mix for the housing market (see here).  Strong housing demand across the board (it’s not just investors that are buying), coupled with chronic housing shortages means the housing market is now very tight and house prices have lifted strongly to reflect that. 

The RBNZ needs to recognise that the housing market risks have shifted dramatically – no longer are they facing the risk of falling house prices, but that of strongly increasing house prices.  And by doing nothing, the RBNZ faces the risk of fuelling the fire of a housing market bubble, which, if underpinned by highly leveraged buyers, can increase financial stability risks down the line.  The subdued inflation print last week will likely support the RBNZ’s conclusion that additional monetary support will still be needed for some time.  Which means the RBNZ’s needs to consider reinstating the LVR lending restrictions at the November Financial Stability review – even if it means going back on its previous forward guidance.