Summary.   A month ago I wrote that the residential real estate market in New Zealand had entered the endgame. This is a situation where the market is still weakening in terms of prices and sales but we can see evidence that the pace of the weakening is itself weakening off.

Less interest rate optimism

Tony Alexander

Wednesday 12 October ‘22

Over the past few weeks there has been quite a change in one of the factors which was probably contributing to the end game appearing, and that is declining fixed mortgage rates. Fixed mortgage rates reached high levels in the middle of June when worries about inflation in New Zealand were at their greatest.

But after the middle of June a wave of optimism swept around the world regarding the track for global inflation. The markets adopted a view that central banks wouldn't have to do much more than they had already signalled and that come the end of 2023 official interest rates would probably be falling again.

As a result, wholesale borrowing costs went down and banks fed this through to decreases between 0.2% and 0.4% for fixed mortgage rates in New Zealand.

Unfortunately, since the beginning of August things have changed somewhat.

Central bankers have expressed deep concern that financial markets were getting ahead of themselves with their optimism about inflation and have made strong comments regarding the need for interest rates not only to go up and potentially higher than the markets have been thinking, but also stay high for much longer.

In addition, some inflation measures have turned out to be higher than expected and a lot of numbers related to the strength of labour markets here and overseas have also been stronger than expected. This is important because it means the pace with which wages growth eventually slows down looks like being slower than previously thought.

The upshot is that fixed borrowing costs have gone back up again and over the past week have received an extra very unusual push higher as a result of the extreme easing of fiscal policy in the United Kingdom. The attempts by the new UK Prime Minister and Chancellor of the Exchequer to stimulate growth in the UK economy are at complete odds with the desire and in fact need of the Bank of England for the pace of growth to slow down so that inflationary pressures can be contained.

Market concerns about new upward pressure on inflation and a blow out in the fiscal deficit have led to a sell off of the British pound to a record low against the US dollar and a sharp jump in UK bond yields which has pushed interest rates up in all other markets around the world as well.

The Bank of England has been forced to enter into the markets to buy UK government bonds and that has soothed some nerves for now.

But considerable concern and uncertainty remains and The upshot of that is that for the remainder of this year it looks like wholesale borrowing costs facing banks in New Zealand are going to be higher than we were hoping as recently as four weeks ago.

Already banks have increased some of their fixed mortgage rates. But apart from the one year fixed rates other rates are still below the levels they reached in the middle of June. I'm sticking with my view that we have seen the peaks for fixed mortgage rates this cycle for all but the one year rate.

Are there implications then for the end game of this period of decline in the housing market around New Zealand? Yes, in that a potential stimulus from falling mortgage rates is now not going to occur until maybe late in 2023. But we still have young buyers pulling back from trying to pick the bottom of the price cycle and deciding to take advantage of the doubling in listings from a year ago to secure a home in which to raise a family.

There are mild indications that investors are pricking up their ears but when I look at the results of my surveys each month of mortgage advisors and real estate agents it is clear that investors still remain very hesitant to buy. It will be interesting to see how that changes if the political opinion polls still show National as being in a position to form a government after next year's general election given their promise to restore interest expense deductibility.

At this stage I remain firmly of the view that we are in the endgame for this period of a weakening housing market around the country and still feel the general bottoming out is going to come sometime around the turn of the year. Of course, if the situation deteriorates further in Ukraine in particular then we should anticipate some extra weakness.

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