Reserve Bank governor Adrian Orr says why he thinks house prices will fall 5%

Thursday, 19 August 2021

Reserve Bank governor Adrian Orr announces the OCR is on hold on Wednesday.

Reserve Bank governor Adrian Orr feels he has good reason to think a fall in house prices is on the horizon – and it is mostly to do with housing supply and migration.

For 10 to 15 years, up until soon after the Covid crisis, the demand for extra homes had been outpacing the construction of new homes, he said.

But the Reserve Bank expects that to be flipped for at least the next three years, as house-building steams ahead and outpaces net migration – which it expects to only recover slowly to about half of pre-Covid levels by the middle of 2024.

The Reserve Bank has always seen soaring house prices as essentially a “supply and demand” problem, so the implications of the central bank’s modelling seem clear.

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It is the main reason the bank is now forecasting “modest” falls in house prices for two years – of the order of 2 or 3 per cent year, starting late next year – amounting to a total drop of about 5 per cent.

The Reserve Bank sees house constructions outstripping new demand by more than 1500 homes a month.

Rising interest rates, tougher loan-to-value controls and changes to tax deductibility rules are also expected to play a part, according to the bank.

Addressing Parliament’s Finance and Expenditure select committee on Thursday, Orr said the demand for extra houses and new construction was going in “polar opposite directions” at the moment.

“I think is probably the most stark diagram I have seen on anything related to housing in New Zealand for a long time,” he told MPs.

“You are looking at houses coming out in the market at record high levels, and you're looking at a very suppressed level of population growth.”

The bank’s projections see about 2500 new dwellings coming on to the market each month over the next year or so, and the extra demand for homes from net migration sitting well under 1000 homes each month.

Speaking to Stuff after the select committee appearance, Orr admitted that the bank could “not be particularly confident” about its net migration forecasts.

Reserve Bank governor Adrian Orr voiced concern in August about the situation recent home buyers might soon be in, and since then prices have risen rather than fallen. (Video first published August 19, 2021)

“It is a simple assumption about the slow opening of the border.”

Its forecast drop in prices of about 5 per cent was just an estimate, he emphasised.

“It could be house prices stay exactly as they are and five or eight years of income growth justifies them, or that we see a correction.”

Orr also muddied the picture by stating the bank couldn’t explain current house price levels “by the simple supply and demand factors”.

“We've had phrases such as ‘irrational exuberance’, talked about,” he told the select committee.

“And this is what is happening on a global basis with housing at the moment.

“The one most common factor when I'm sitting here chatting with central bank governors around the world, which is regular, is the rapid rise in house prices – asset prices – globally; both equity prices and house prices.”

Part of that was because interest rates are low, he acknowledged.

The Reserve Bank delayed implementing the first of an expected series of OCR hikes on Wednesday, because of the community outbreak of Delta.

“And a big part of it is because people have diverted spending and investment back into these types of activities.

“I don't want to call things bubbles, I don't know if it's helpful at all. I would say house prices are above the sustainable level.”

But the overall messaging was clear.

High house prices are not the Reserve Bank’s fault and the “market” is about to ease the problem a little.

“I'm going to cut right to the chase,” Orr told MPs.

“We need more houses, and we need more houses across the full spectrum … mucking around on the demand side is not going to resolve the issues around housing; it is a supply side issue.”

Orr dismissed the suggestion the bank had “turned on the monetary hose too hard” last year.

“I stand by everything we've done and I'm incredibly proud of everything we've done which has been critically necessary,” he told MPs.

“Our mandate is to contribute to maximum sustainable employment. We are there. Our mandate is to maintain low and stable inflation expectations around 2 per cent. We are there.

“We have had the strongest operating economy in the globe. And the reason house prices are where they are is because employment has proved to be stronger; it is because we have had a robust economy.”

If the monetary policy response to Covid does contribute to some people who timed purchases unluckily losing out in a correction, that was not within the bank’s control, Orr indicated.

“Some households, more recently, who chose to invest in housing, or buy housing, because of the emotive behaviour we have talked about may find themselves under some financial stress.

“We cannot operate monetary policy to the suitability of every household,” he said.

“At present, the vast majority of people who are homeowners will be absolutely fine. They've been in the market for a long time.”