Rosie Smyth and Richard Larsen, along with their toddler daughter, had spent years looking for an affordable home in Lyttelton, a small port town at the edge of Christchurch where Smyth grew up. They were hunting in the midst of New Zealand’s housing affordability crisis when prices rose to nearly nine times the average income. The market had a frenetic quality – every month seemed to bring a new rise, and with it the feeling, Smyth says, that if you didn’t get in now, prices could permanently dance out of reach.
New Zealand’s homeowners are looking down the barrel of an era of financial instability: huge leaps in interest rates will pile pressure on the budgets of many households, particularly those who bought in the past three years when the market was at its peak. The Reserve Bank raised the official cash rate by 75 basis points to 4.25%, in an unprecedented effort to counteract the country’s stubbornly high inflation.
A number of factors make the country’s housing market unusually vulnerable to a crash, it has one of the world’s highest price-to-income ratios, and most of New Zealand’s mortgages are fixed on very short terms of one to three years, with about half of all mortgages due to be refinanced in the next year.
The interest rate rises mean that when many of New Zealand’s homeowners are forced to refinance their mortgages, they will be doing so at rates that are more than double or triple what they are currently on.
Calculations like this – whether to take a holiday, go out for a birthday dinner, or splash out on a Christmas present – will be made around the country as households look at their budgets and gauge whether they can absorb hundreds or thousands of dollars in extra payments on their mortgage. Collectively, those small decisions will send shock waves through the wider economy.
The sectors set to feel the pain are the service industry, tourism, hospitality, and small businesses – many of the same sectors that suffered the most during the pandemic. That is horrible for the economy – because so much money is being sucked out of the economy and it’s been redirected toward paying interest, which in this country goes to foreign banks, largely.
It’s this phenomenon that places housing shocks as a particular threat to the wider economy. Economists at the University of California have argued that credit-financed housing price bubbles are the most dangerous type of bubble for triggering a financial crisis. Another study found consumption falls by between five and seven cents for every dollar fall in housing net wealth.
In New Zealand’s case, a limited, or shallow recession is exactly what the Reserve Bank (RBNZ) is aiming for. “Think harder about your spending. Think about saving rather than consuming, I know that’s a strange concept,” Reserve Bank Governor Adrian Orr said.”
But reducing household spending is a blunt instrument to reign in inflation, and bank economists say it is laying the path for a bleak and rocky year ahead. “Make no mistake, the RBNZ is not just signaling a recession, it’s forecasting a downturn on a similar scale to the global financial crisis – different causes, but similar consequences,” said Michael Gordon, Westpac Bank’s acting chief economist. “For the first time in a while, we’re also thinking about the risk that the RBNZ could end up overcooking it on the inflation front.”
New Zealand’s house prices began dropping sharply this year. In Auckland, the country’s largest city, median prices last month dropped 12.7% year on year while the rest of the country fell 7.5%.
Investors in housing will be feeling the heat of a number of policy interventions on top of rising interest rates: a tax on capital gains on properties bought and sold within 10 years, and the loss of interest deductibility on their tax bills. With the majority of New Zealand’s total wealth – more than 57% – tied up in housing, that could also mean the evaporation of many households’ primary assets. So much debt is held by households in this country, by owner-occupiers and investors, so much wealth will be evaporated if there was a collapse in house prices.
