Editorial: Reserve Bank house warning hard to accept

House price inflation in Auckland is running at 11 per cent. Photo / Janna Dixon

Does anybody believe the warning from the Governor of the Reserve Bank that Auckland house prices could crash, or in economic jargon, suffer a "sharp correction"? The Prime Minister supported him. "We are building a lot of houses in Auckland now. People can get a bit carried away with the fervour of these things and believe it is all going in one direction. History shows you house prices go up and down."

Recent history has not shown us that. When the long bubble burst in 2007 and the world suffered its worst financial crisis since the 1930s, Auckland house prices fell only 5 per cent and soon recovered. Hardly anyone believes they are going to slump any time soon and, furthermore, we do not believe the Governor or the Prime Minister believe they will either. Markets understand why they say this.

The Reserve Bank was under some pressure last week to cut its base interest rate. The Reserve Bank of Australia did so, following an easing of monetary policy by the central banks of India, Canada, Singapore, Denmark and the European Central Bank in recent weeks. Fears of deflation in Europe, heightened by the drop in oil prices last month, caused something of a panic.

Graeme Wheeler, to his credit, did not follow suit. The previous week he had changed his outlook on the likely interest rate trend from "up" to "up or down" but those who took that as a signal he would announce a cut on Thursday turned out to be wrong. Though he expected inflation to be below the bank's 1 to 3 per cent target "and could be negative for a period during 2015" (the dreaded deflation), he considered it better to leave the interest rate unchanged for now.

One of the reasons for that is Auckland house prices. House price inflation in Auckland is running at 11 per cent, he noted, but if he really expected a sharp correction he would probably have lowered the official cash rate.

Of course there are other reasons to keep a wary eye on general inflation despite it going lower. The economy is growing, immigration is strong, employment is at record levels and business and consumer confidence is high. Not many economies in the world are doing as well.

A period of deflation this year might hardly be noticed. Deflation is usually dreaded because it discourages consumer spending - people put off buying when they realise prices are declining - and the economy goes into a slump that can be hard to reverse. But the Governor obviously sees no such risk in New Zealand this year.

For that, too, perhaps we have house prices to thank, though it would be idle to ignore the harm they are doing in other ways. It is not the Reserve Bank's brief to worry about affordability though it sometimes seems to be doing more about this than the Government.

The Government believes it can contain prices by increasing the supply of houses without acting to discourage demand. The bank has restricted low equity lending and the Governor frequently warns prices can fall. It is just a pity we cannot believe it.

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