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LVR restrictions adopted, but will they work?

RBNZ Observer Update
LVR restrictions adopted, but will they work?

The RBNZ today announced restrictions on high loan-to-value ratio (LVR) lending to cool the housing market. However, we expect these restrictions will have only a minor impact with the expected boost to demand from the recent rise in inward migration likely to offset the effect of lending restrictions. Overall, with house price inflation likely to remain elevated and momentum continuing to build in the broader economy we still expect the next cash rate move will be up and could come around year end.

Facts

- From 1 October 2013, New Zealand banks will be required to limit residential mortgage lending with an LVR over 80% to no more than 10% of new lending.

- Given the existing pipeline of loan approvals, banks will initially be allowed to meet the LVR restrictions as an average rate over a 6-month period. Thereafter, the limit will apply to the average rate over three-month rolling windows.

- Small banks (lending below $100m) will continue to have restrictions enforced over a 6-month rolling window, given their greater volatility in high LVR lending.

- The new policy will remain in place until there is ‘evidence of a better balance in the housing market and [the RBNZ] are confident that their removal would not lead to a resurgence of housing credit and demand’ or ‘if the measures are not considered to be effective.’

Implications

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The RBNZ today announced the implementation of LVR restrictions on lending in the New Zealand housing market. The central bank is concerned that the recent strong rise in house prices, and the associated credit growth, is leading to a build-up in financial stability risks – given already stretched valuations in the New Zealand housing market.

Further, given the starting point of low inflation, and an elevated exchange rate, the policy option of raising interest rates to dampen the housing market is viewed by the RBNZ as inappropriate – given this would unnecessarily crowd out other sectors of the economy, particularly those that are exchange rate sensitive.

All else equal, today’s policy should limit the build-up of financial stability risks at the margin. However, as we have outlined in recent research we expect the policy to have only a minor impact on New Zealand’s housing market.

Instead, a combination of low interest rates, rising inward migration and supply-side constraints are likely to see house price inflation remain elevated for some time. House price inflation is unlikely to moderate significantly until policy rates begin to rise, in our view.

At the same time, momentum in the wider New Zealand economy continues to build – with a broad range of data pointing to robust growth over Q2 and into Q3 2013.

As such, we still expect a combination of a booming housing market, the boost provided by the Canterbury rebuild and rising momentum in other sectors to see the New Zealand economy hit capacity constraints sometime soon. As a result, the RBNZ may need to contemplate raising policy rates, a move that could occur around the end of the year.

Bottom line

The RBNZ today announced LVR restrictions to limit financial stability risks building in the New Zealand housing market.

We expect the impact of these measures on the housing market to be modest, with low policy rates, rising migration and supply-side restrictions continuing to provide support for house price growth.

With broader momentum building in the New Zealand economy, the RBNZ may need to contemplate raising the cash rate, a move that could occur around the end of the year.

ENDS

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