Reserve Bank has poor record forecasting house price inflation

By NZPA

Wednesday 30th May 2007

Whether or not the Reserve Bank hikes interest rates again on June 7, governor Alan Bollard is near certain to pepper his commentary with fresh warnings about the housing market being over-heated and destined to fall.

Ever since the Reserve Bank got operational independence in 1988 with a sole objective of keeping inflation under 2 or 3%, it has been mystified that house price inflation has heavily outpaced inflation.

Soon after his appointment in 1988, former governor Don Brash infamously advised it would be a better investment to rent than buy in a low inflation environment, then promptly proceeded to buy.

Examining comments on housing in the last 14 of the bank's quarterly Monetary Policy Statements (MPS), two common themes emerge -- the bank's economists are repeatedly surprised at the strength of the housing market, causing the bank to under-estimate inflation pressures; and equally often they predict a downturn soon.

The Reserve Bank can't say how many of its 230 staff are devoted to forecasting but it has an economic unit, a forecasting unit, a research unit and a modelling unit, nearly all of whom will be paid $100,000-plus salaries. As well, others in its financial markets, communications and other divisions are involved in the process.

The longer the housing boom lasts the more probable the bank will eventually be correct, but so far those who have ignored its advice have fared materially better than those who listened to its monetary experts.

Excerpts about housing from the most recent MPS:

March 2007

"Further out we assume that house price inflation will fall to more moderate levels, eventually reaching zero at the end of the forecast period.

"Over recent years, we have been surprised by the resilience of the housing market and the willingness of households to take on additional debt.

"However, house prices look stretched across a variety of measures."

December 2006

"Housing market activity continues to exceed our projections. "Worrying, there are tentative signs that housing market activity could be regaining momentum.

"The housing market has remained more robust than we expected in the September statement. We have revised upwards our projection for house prices over 2007/8 although we still expect a declining rate of growth followed by a long period of weakness in house prices, especially in real (inflation adjusted) terms."

September 2006

The bank noted housing market activity had slowed over the past year.

"House price inflation is well off its 2004 peaks, and we expect to see a further slowing, reflecting the dampening influences of lower immigration and rising effective mortgage rates.

"However, the housing market outlook remains uncertain, with risks to the upside. To date, the slowing in house price inflation has been more gradual than expected and there is a chance that it could continue to surprise on the upside."

But the projections still forecast house prices would fall by 5% by 2007.

March 2006

The bank said house prices may be over-valued and the recent strength in house price inflation had left house prices at very high levels relative to incomes.

"We are projecting a sharp decline in house price inflation over the coming years, although there are considerable uncertainties around this projection.

"On the one hand, even the modest house price deflation that we are projecting would leave the ratio of house prices to income very high by historical standards. On the other hand, house prices have surprised us with their strength over recent years."

December 2005

It said house prices were around 15% higher than the bank envisaged at the same time a year earlier, "highlighting difficulties inherent in forecasting asset price cycles and their influence on economic activity".

It pointed to a "quite dramatic" fall prices in Australia and the UK and "the magnitude of the projected slowdown in New Zealand house price inflation appears to be on par with what has already occurred in these two countries".

While it said it expected house price inflation to remain strong in the near term, it added: "We are projecting a sharp decline in house price inflation in the company years. We project quarterly house price inflation to turn negative at the end of 2006."

September 2005

It said house price inflation has been slightly stronger than expected over recent months.

"We continue to project a sharp decline in house price inflation in the company years as lower net immigration and higher interest rates slow underlying demand."

(In October, Dr Bollard stated the uptrend in house prices wouldn't be sustained and an outright fall in prices was "likely".)

June 2005

While the housing market has softened, it has not slowed to the extend we had expected, the bank said.

"Lower net immigration and higher interest rates are the driving factors behind our projection of a sharp decline in house price inflation in the coming years. However, reflecting recent house price data, we expect the fall in house price inflation to occur slightly later than we projected in the March statement."

March 2005

"We project that house price inflation will slow markedly over the coming years, reflecting lower net immigration and higher interest rates."

December 2004 Some indications still suggest a turning point is near, said the bank.

"This assessment is largely based on continued signs of slowing in housing market activity and lower net migration. The very strong house price inflation cycle now appears to be past its peak. "With lower net immigration and increasing effective mortgage rates, we project that house price inflation will slow markedly next year."

Sept 2004

The are already signs of a slowdown in some sectors, such as a the housing market, the bank said.

"The very strong house price inflation cycle over recent years now appears to be past its peak, possibly as a result of slowing net immigration. We project that house price inflation will slow markedly over the coming years."

June 2004

"We are placing considerable weight on a cooling in housing market activity -- already starting to become evident in the data -- as a factor likely to moderate growth in spending over the next year or so. "We expect falling house price inflation."

March 2004

Momentum in the housing market also appears to be slowing, but current activity levels remain very high following a record number of house sales in 2003, it noted. "However, houses are still selling very quickly, suggesting that demand for house remains strong.'

December 2003 The expected shift in migration trends will reduce housing demand relative to the now rapidly increasing supply, said the bank. By 2005, slowing population growth is likely to reduce the demand for new houses, which will see residential investment decline from its cyclical peaks.

Sept 2003

"As the drivers of housing demand moderate, we expect to see a reduction in house price inflation."

For the record, the Real Estate Institute figures show the national median house price was:

Year Median price Percentage gain

2007 $349,000 14.4

2006 $305,000 12.6

2005 $272,000 12.1

2004 $242,000 12.4

2003 $202,000 19.8

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