RBNZ Rate Cuts Ahead as Dairy Sector Slowdown Outweighs Rising House Price Concerns
The Financial Stability Report (FSR) from the Reserve Bank of New Zealand (RBNZ) gave no surprises: the financial system remains sound and effective but housing and dairy remain key risks for the New Zealand economy.
The RBNZ said there were heightened financial system risks due higher housing prices and a weak dairy outlook.
The FSR did not contain any new macro-prudential policy tools aimed at the housing market. Rumblings about new debt-to-income ratios did not materialise. Aside from the possibilities that such may not have been worthwhile to the RBNZ and the lengthy implementation period, there is no consistent definition of income across the banks, which would be needed to put this into effect.
The November 1 changes to the LVR restrictions have been too recent to judge its effectiveness and true impact on the Auckland housing market. Nonetheless, the RBNZ expects its new LVR measures to aid in moderating housing prices, and improve the resilience of banks’ balance sheets.
Early estimates from the RBNZ report that these new LVR measures will, in time, effect around 13% of Auckland housing transactions and moderate house price inflation by 2 to 4 percentage points throughout 2016.
On the other side, housing prices outside of the geographic restriction of the LVR measures are experiencing relatively high annual house price growth. For example, in Hamilton annual house price growth is 18% and Tauranga is 14%. Noting this, the RBNZ has pledged to monitor the impact of the relaxed LVR speed limit outside of Auckland.
Capital buffers for system resilience were also noted in case of a decline in housing prices. A downturn in labour incomes, a sudden rise in mortgage rates, an unexpected reversal in investor appetite or a reversal in migration flows can trigger such a correction in the housing sector.
The RBNZ reports a weak dairy outlook since the May FSR remains a key risk to the financial system. The dairy industry has faced a second consecutive season of poor cash flows. Also, farm revenues are forecasted to be under break-even levels. Since August, dairy prices have made slight gains but some farmers will likely be under financial strains into the next year.
The RBNZ forecasts higher dairy prices over the medium term.
However, the central bank also comments that dairy prices are slow to recover. In addition, there is a high probability that some regions in New Zealand could experience a drought in summer, which will put further pressure of dairy farms. And if dairy prices fall significantly, this can intensify the problem.
Based on limited number of transaction in recent months, the RBNZ concludes that dairy farm prices are declining. The RBNZ states banks need to “set aside realistic provisions for the likely increase” in faulty rural loans but also believes the banks’ “credit losses on dairy exposures are expected to be manageable”.
The RBNZ also notes that farm prices “appear to be less overvalued than prior to the GFC” but “there is a risk that downward price movements are amplified by market illiquidity”.
ASB still predicts a 25bp Official Cash Rate (OCR) rate cut in December.
Nick Tuffley, ASB Chief Economist states, “The strength of housing will be one factor the RBNZ bears in mind when making near-term OCR decisions. But we still expect a 25bp OCR cut in December, given the inflation outlook is extremely benign in our view and house sales fell sharply over October. Our inflation outlook is actually so low now that we still see some risk of even further OCR cuts in 2016.”
