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Higher interest rates not the right answer for housing bubble, RBNZ's Spencer says

Thursday 27th June 2013

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The Reserve Bank says raising interest rates now isn't the right policy response to an overheated housing market and the bank considers restricting low equity home loans as offering the "greatest potential" to curb demand.

Deputy governor Grant Spencer told the Business NZ Council in Wellington that the "overheated housing market is a real threat to future financial stability" and while a shortage of supply was the root cause, low interest rates spurring demand was underpinning the "rapid escalation in house prices."

While the bubbling property market is leading to increased consumer spending, it isn't yet threatening overall inflation, which is sitting at an annual pace of 0.9 percent, and any hike in the record-low official cash rate may put "unwanted" pressure on the currency.

"For these reasons, higher interest rates are not the right policy response at this time," Spencer said.

The bank favours imposing restrictions on the high loan-to-value ratio home lending, which "offers the greatest potential for moderating the current excesses in the housing market," Spencer said.

"LVR restrictions have the most potential to reduce risk both by making bank balance sheets less risky and by dampening housing market pressures through reduced credit supply," he said.

In setting monetary policy, the central bank has been juggling competing inflationary impacts of a strong currency, which keeps imported prices down, against the threat of rising house prices fuelling consumer demand and pushing prices higher.

Spencer said the tools were developed to address this type of imbalance, and "the Reserve Bank is therefore seriously considering the use of macro-prudential policy."

Last month Reserve Bank governor Graeme Wheeler and Finance Minister Bill English signed off on granting the regulator new macro-prudential tools, including LVR restrictions, as a means to head off potential asset bubbles. The bank is consulting with lenders on the technical implementation of LVR restrictions.

Spencer said the central bank doesn't want to ban low equity home lending outright, instead preferring a "speed limit approach" where banks would assess which customers would qualify for high LVR mortgages based on their own lending criteria.

Any restrictions on low equity home loans would only apply to new lending, and the central bank would prefer a policy of no exemptions, in contrast to Prime Minister John Key's preference to see first-home buyers carved out.

While the central bank isn't mandated for social equity, Spencer said limiting the accessibility of credit in the short-term should make housing affordable over a longer timeframe by taking the steam out of a bubble.

The introduction of LVR restrictions contains risks, and needs banks to cooperate for it to be successful, he said.

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