The Reserve Bank says a deeper housing correction could be on the cards as property prices remain above sustainable levels.
Home prices are down 4% from their peak last November, after rising 48% in two years.
The central bank’s semi-annual Financial Stability Report says recent buyers with limited equity are vulnerable to declines, and a sharp drop would significantly reduce wealth and lower consumer spending.
He said high property prices, the war in Ukraine and the Omicron outbreak mean that short-term risks to the financial system have increased.
But the RBNZ said New Zealand’s financial system remains well placed to support the economy. He also did not rule out a global recession in the coming months.
READ MORE: Home prices are expected to fall in most major cities this year
However, the housing market continued to pose a risk to the economy.
“While a gradual decline in house prices to more sustainable levels is desirable from a financial stability perspective, a sharp correction remains a plausible outcome that would have broad economic implications.
“Relative [to] Based on December 2021 prices, we estimate that a 30% decline in house prices could cause the outstanding mortgage debt to fall by around 10% into negative equity (the value of the property of the borrower being less than the amount of the current mortgage loan), ” the report mentioned.
The report indicates that debt servicing costs will rise significantly as current fixed rate mortgages are repriced over the coming year.
“Some recent mortgage borrowers are vulnerable and may have difficulty repaying their debts, but overall the threat to the financial system is limited.”
But it meant some households will have to tighten their belts to manage the impact on their finances.
He said banks were keeping test interest rates in their service capacity assessments at around 6%, above current mortgage rates, providing reassurance that buffers are in place.
He said household balance sheets remained strong and loan-to-value restrictions had limited the accumulation of risky debt as house prices rose.
“Debt service vulnerabilities do not pose a significant threat to the stability of the financial system at current mortgage rates, although some more vulnerable households could face stress from a combination of further large increases in mortgage rates and the cost of life,” the report said.
The RBNZ said that, as with households, corporate debt servicing costs also rise with interest rates.
But on its own, the bank said it was unlikely to cause financial stress given the low starting point for interest rates and general corporate deleveraging in recent years.
“However, when combined with other cost pressures and reduced spending due to the Omicron outbreak, some businesses are likely to become stressed.”
He said low interest rates during the pandemic have led to lower debt service costs, increasing borrowing capacity and the share of new loans at high debt-to-income (DTI) ratios.
But the RBNZ reiterated that it was in the process of designing a framework for putting DTI restrictions in place.
He said the analysis showed first-time home buyers would be least affected by a DTI restriction, with investors most affected as they tended to borrow at higher DTIs than other groups.
The RBNZ planned to finalize the framework by the end of this year so restrictions could be introduced by mid-2023 if necessary.
He also said rental yields remained historically low as interest rates continued to rise, meaning rental property has become a less attractive investment.
“This indicates increased pressure for rents to rise or house prices to fall, to bring rental yields in line with yields on other assets,” the bank said.