Reserve Bank of New Zealand Governor Graeme Wheeler said the nation’s currency may be driven higher when he starts raising interest rates next year, as major economies are unlikely to increase borrowing costs.
“The concern will be that the interest differential between New Zealand and any of the advanced economies will widen,” Wheeler told a parliamentary committee in Wellington today. “That could increase pressure on the exchange rate and put the traded goods sector under more pressure.”
New Zealand is set to become one of the first nations in the developed world to increase borrowing costs as surging home prices and the rebuild of earthquake-damaged Christchurch fuel inflation pressures. Wheeler last month introduced limits on low-deposit home loans to try to slow an overheated housing market and delay raising rates. The RBNZ said in its semi-annual Financial Stability Report earlier today there are signs that the lending restrictions are starting to work.
The nation’s currency dropped. The New Zealand dollar traded at 81.99 U.S. cents at 1:35 p.m. in Wellington, from 82.25 cents before the stability report was released.
“A strengthening economic activity backdrop will need to be countered by a higher official cash rate,” Mark Smith, senior economist at ANZ Bank New Zealand Ltd. in Wellington, said in an e-mailed note. “Nevertheless, supportive prudential policy measures, the high New Zealand dollar, and restrictive fiscal policy settings are expected to be factors tempering future official cash rate lifts.”
The RBNZ said while New Zealand’s financial system remains sound, imbalances in the housing market pose the biggest stability risk. It joins other small and open economies such as Singapore and Hong Kong in using tools beyond the benchmark borrowing rate in a bid to curtail surging house prices.
Prices rose 8.9 percent in October from a year earlier, the fastest annual pace since January 2008.
Under the RBNZ’s lending limits introduced on Oct. 1, loans for more than 80 percent of a property’s value must account for no more than 10 percent of a bank’s new lending, down from about 30 percent.
While it’s “too early” to assess the impact of the limits, annecdotal reports of waning buyer interest and transaction volumes are evidence the measures are “starting to affect the housing market,” the RBNZ said in the stability report.
“It was possibly a little bit more strident in terms of the message,” said Chris Green, director of economics and strategy at First NZ Capital Ltd. in Auckland. “Despite it being too early to draw conclusions, they are seeing a change in market behavior. So potentially it means interest-rate hikes won’t come as early as may have been expected.”
Wheeler last month said he expected to start raising the Official Cash Rate from a record-low 2.5 percent next year. Sustained strength in the exchange rate provides the RBNZ with greater flexibility as to the timing and size of future rate increases, he said.
“The New Zealand dollar trade weighted index remains at elevated levels,” the RBNZ said in today’s report. The dollar has been rising since early September, reflecting the strengthening outlook for the domestic economy, it said.
Wheeler last month said the economy grew more than 3 percent in the year through September. Employment rose 1.2 percent in the third quarter -- the fastest jobs growth since 2007, according to a Nov. 6 government report. In his testimony today, Wheeler said inflation pressures are building.
In its report, the RBNZ said a further risk to financial stability is the high level of debt among dairy farmers, which increases their vulnerability when commodity prices decline. It urged farmers to be mindful about future borrowing and to use current high incomes to repay debt.
The broader economy faces vulnerabilities associated with high external debt, which is the result of a persistent current account deficit, Wheeler said. The RBNZ expects the deficit to worsen as residential investment expands over the next two to three years, he said.
“It is important that the improved savings performance is maintained and that the public sector deficit continues to reduce,” he said.