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Monthly Economic Indicators

Special Topic: Outlook for the housing market

The housing market has weakened considerably since our previous update in the September 2007 Monthly Economic Indicators,and even since our Half Year Update was released in December 2007.  This special topic provides an update on recent developments in the housing market and the implications for residential investment and private consumption.  Figure 9 illustrates the close relationship between house prices and consumption, highlighting the importance of the housing sector.

Figure 9 – House Prices and Consumption
Figure 9 – House Prices and  Consumption.
Source: Statistics NZ, REINZ

The housing market is slowing …

Data available from Real Estate Institute of New Zealand (REINZ) shows that annual average growth in the median house price declined to 11% in the December quarter 2007 (Figure 9).  Additional REINZ data suggest a major correction in the housing market has begun to take place: house sales for the year to January are 31% lower than one year ago.  The median number of days to sell a house (41 on a seasonally adjusted basis) is also at recent highs.  Finally, median house prices on a monthly basis have essentially remained flat for the past 10 months.

The weak data relating to sales has begun to feed through to residential building consents. The trend value of consents (both total and excluding apartments) has been decreasing since July 2007.  The fall in consents looks set to continue in the near term given the relationship in Figure 10.

Figure 10 – House Sales and Consents
Figure 10 – House Sales and Consents.
Source: Statistics NZ, REINZ

Other data help to build a more complete picture of the market.  The quarterly ASB Confidence Index released in February shows the net balance of respondents expecting house prices to rise over the coming year continues to fall.  The National Bank Business Outlook tells a similar story with an increasing number of respondents believing residential investment will soften in the next 12 months.  Consistently weak housing data has convinced us that the housing market has begun a period of correction.

… as borrowing costs increase and net migrant inflows fall

There are two fundamental drivers of the slowdown in the market for existing homes: higher borrowing costs for households and weaker net migration.

Four successive increases in the Official Cash Rate (OCR) by the Reserve Bank last year have slowed momentum in the housing market as the demand for existing houses wanes.  The effect of current international developments is also an important influence on borrowing costs.  Financial markets have been in a state of turmoil following the fallout from the “subprime” crisis in the US.  Banks are tightening lending criteria, and rates are increasing despite no increases in the OCR since July 2007. The effective mortgage rate (the average rate for the pool of borrowers) continues to increase as borrowers roll over fixed term loans at higher interest rates.  Currently, the effective rate is 8.50%, a full 50 basis points above last year’s rate and will continue to increase as fixed rate mortgages are reset (more than a quarter of all home loans are due for re-pricing in the next year).

The other fundamental factor compounding lower demand is a drop-off in net migration.  For the twelve months to January, arrivals exceeded departures by just 4,800 people after falling from 14,100 a year ago.  As evident in Figure 11, net migration and house sales move together as higher population growth increases the demand for housing.  These trends are reflected in sales (and prices) of existing homes first before leading to an increase in residential building consents and work put in place.  If net migration remains low, annual figures will continue to fall, pointing to a further easing in sales.

Figure 11 – House sales and migration
Figure 11 – House sales  and migration.
Source: Statistics NZ, REINZ

The tight labour market is offsetting these two fundamental factors to some degree. Recently, the participation rate and the unemployment rate reached a record high and low respectively and wage growth has remained high. However, the labour market on its own is unlikely to be able to support current prices of homes.

Implications of a weaker housing market for GDP

A weak housing market impacts on economic growth through a variety of channels, particularly by lowering residential investment and private consumption.

Recent falls in house prices and sales point to lower growth for investment in residential property.  Once we consider further increases in lending rates, a declining trend in dwelling consents and recent falls in net migration inflows, we see residential investment falling further than previously expected in the short term.  As house price growth moderates, the growth in potential collateral also eases, making it more difficult for borrowers to continue accessing new funds.

The link between house prices and private consumption is also strong.  In the last few years we have seen an increase in consumption due to rising house prices.  Homeowners feel wealthier due to higher prices and may extract some of the equity from their homes for spending on goods and services.  As house prices begin to correct, we expect to see less equity withdrawal and a lower profile for spending growth as households consolidate. Another way a slowing house market will impact on private consumption is through a fall in the demand for durable goods.  A number of durable goods are complementary with housing (such as whiteware and furniture) so as the housing sector weakens, we expect growth in sales of these goods to also decline.

In the Half Year Update we expected house prices to moderate in the near term and residential investment levels to fall by the end of 2008.  It is now apparent that both annual growth in residential investment and house prices will be declining sooner than previously thought.

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