The Reserve Bank will be forced to slash interest rates in the second half of next year in the face of a tanking housing market, independent global researcher Capital Economics believes.

Capital, which has been forecasting since January this year that falling house prices will force the RBNZ’s hand, is now predicting New Zealand house prices will drop 20% by the middle of next year.

And it says the reaction will be three cuts to the Official Cash Rate, totalling 75 basis points, in the second half of 2023.

Capital Australia & New Zealand economist Ben Udy, who was early last year first to forecast that the RBNZ would need to start raising the OCR, says house prices in New Zealand “are tumbling and all signs point to a further deterioration in the months ahead”.

“On that basis, we are revising up our forecast for the peak to trough decline in prices from 10% to 20%. That’s why we expect the RBNZ’s hiking cycle to go into reverse earlier than most anticipate.

“We were one of the first to forecast a significant housing downturn in 2022 when we made the prediction a year ago. REINZ median house prices have been generally falling since November last year and are now more than 5% below their peak. Prices are still higher than they were a year ago but the weakness in sales indicates that the downturn is set to intensify. That suggests that our forecast of a 10% peak to trough fall in prices is far too small.”

Udy said since making the earlier forecast of house price falls, the outlook has deteriorated.

“First, we now expect the Reserve Bank of New Zealand’s policy rate to peak at 3.5% instead of the peak of 1.25% we had anticipated last year.

“What’s more, the government introduced responsible lending laws that contributed to housing credit growth slowing from 12% [year-on-year] in the middle of last year to 8.7% in March.

“Admittedly, our previous expectation that the RBNZ would implement DTI [debt-to-income] restrictions now looks unlikely. But we were right that housing affordability was set to become more stretched than ever before. And in the months ahead, rising interest rates will more than offset the impact of falling prices and stretch housing affordability even further.”

In a global outlook on houses in March, Capital economists had singled out the NZ housing market as one of the ones they were most worried about.

Udy noted that New Zealand has experienced just one significant housing downturn since the 1990s, which occurred in 2008 following the global financial crisis.

“Our forecasts for interest rates would be consistent with prices falling 15% y/y before long and keep falling until the around the end of 2023. (See Chart 1.)

“That suggests the downturn may result in a 20% fall in prices.

“Even such a large drop in prices would only restore affordability to its late-2021 level or its pre-GFC peak, which would still be very stretched. (See Chart 2.)”

The RBNZ recently indicated that house prices would become ‘sustainable’ if they were about 5% to 20% lower than they are currently.

Last week, when hiking the OCR to 2% and signalling the OCR would hit nearly 4% by the middle of 2023, the RBNZ said it saw house prices falling, from peak to trough by about 15% by 2024.

Udy still expects the RBNZ to continue hiking rates until the end of this year. 

He believes the housing downturn will be a “drag” on the NZ economy.

“…And the hit to construction activity will grow as both the length and the depth of the downturn increases.

“But the deeper downturn will have more severe implications for recent home buyers.

“The RBNZ estimates that if house prices fell by 30% then 10% of mortgage holders would be underwater, that is, they will have mortgages that are larger than the value of their homes. That situation can lead to an increase in defaults.

“Admittedly, a 30% price rise would be much larger than we anticipate. And defaults are currently very low, so a small rise wouldn’t be a significant concern for the financial system.

“But we suspect that even those underwater households that avoid default will tighten their belts considerably.

“That’s another reason to expect a slowdown in consumption growth in the years ahead,” Udy said.

By the middle of next year, he thinks the impact of the housing downturn “will be painfully clear”.

“And we think house prices will be at the bottom of the RBNZ’s estimated ‘sustainable’ range.

“On that basis, we think the Bank will cut rates by 75 basis points, starting in the second half of next year.

“That should be enough to stabilise the housing market and support a rebound in GDP growth.”