KEY POINTS:
In the second part of our special, the Herald examines how housing and the labour market can restore balance to the economy.
For businesses seeking relief from high interest and exchange rates, the continuing strength of the housing market can seem like the oppressive heat before an electrical storm.
The Reserve Bank is counting on the housing market to weaken in order to turn off the wealth effect, whereby home owners increase their debt to spend a few cents in every dollar of their increasing housing equity. That has seen consumer spending grow faster than incomes for several years.
The bank is counting on a couple of years in which consumer spending - about 60 per cent of economic activity - goes sideways in real terms, in order to vent inflation pressures.
Its problem is that inflation in the non-tradeables side of the economy, where prices are not affected by the exchange rate or disciplined by international competition, has been stuck around 4 per cent for the past couple of years. As long as that remains true, headline inflation - now falling - could swiftly climb again should international oil prices rise or the New Zealand dollar fall sharply.
Although the Reserve Bank continues to forecast that house price inflation will decline, and even dip into negative territory, it admits in its September monetary policy statement that the slowdown has been more gradual than it had expected. So monetary conditions - interest rates and the exchange rate - remain tight.
The Real Estate Institute reported a jump in the median national sales price last month to $324,000 after four months in a tight range of $310,000 to $313,000. The median price has climbed 72 per cent over the past five years, compared with just 14 per cent over the five years before that.
Quotable Value says the average house price over the three months to October was 9.6 per cent higher than in the same period last year. While that is down from the 2004 peak of house price inflation at nearly 25 per cent, it is still a far cry from zero or a negative figure.
Although a correction in the housing market is a risk, it is not a particularly large risk, says Bank of New Zealand chief economist Tony Alexander.
"This is because the labour market remains tight, net migration inflows are running above average and even if the Reserve Bank raises its nearly meaningless official cash rate again we still expect mild downward movement in fixed mortgage rates next year as monetary policy is eased in the United States," he said.
Even though the economy has been growing at a well-below-par average rate of 0.5 per cent a quarter for two years, the unemployment rate is only 3.8 per cent and wage inflation is high.
"We never reached critical mass in the slowdown," Alexander said. "You get unemployment shooting up when businesses lose hope and act on that."
Business confidence fell sharply in the second half of last year but businesses did not act on that by shedding labour. "They were hoping everybody else would lay off employees so they could hire them. The downward spiral simply hasn't got going this cycle."
Westpac chief economist Brendan O'Donovan said firms had gone into the slowdown with a shortage of skilled labour, so in its early phase continued to hire. Job security had helped underpin the housing market.
"But when the housing market does run out of steam the economy will be in for a tough transition period," he said.
"We have seen corrections in the housing markets in Australia, the United Kingdom and the United States over the past 2 1/2 years. I'm not sure why New Zealand would be immune."
When that would happen was impossible to predict, because the market was being driven by sentiment.
ANZ National Bank chief economist Cameron Bagrie said he did not expect to see a substantial turn in the housing market until the labour market turned. Other gauges of the property market gave a picture of a market that remained brisk but vulnerable.
House prices continued to grow faster than household incomes, leading to declining affordability.
The average house price was eight times the average income, compared with six times in Australia.
Household debt was rising and interest rates too, as a surge of two-year fixed-rate lending taken out during the "mortgage wars" in late 2004 came up for repricing.
But Bagrie said housing market turnover and the number of building consent issues showed a pick-up in activity consistent with rising net inflows of migrants.
Alexander said he expected slowing growth in the US to lead to falling interest rates over the year ahead, which would translate into slowly falling fixed-term rates in New Zealand.
"Even as the floating interest rate remains high along with one-year and possibly two-year rates, fixed rates for three years and beyond will decline."
MIXED SIGNALS CONFUSE PICTURE
Talk of a hard landing for the economy has so far come to nothing. Indeed, over the past month there have been signs that the economy may be picking up speed again. But there are also reasons to believe this may be a blip and not a longer-term trend.
Signs of an upswing
* Business confidence is the highest for two years and firms' views of their own outlook is at levels not seen since early last year.
* Retail sales in the September quarter were up 1 per cent on June in real terms.
* Imports hit a record of $3.9 billion last month as the country pulled in $1.43 of imports for every $1 of exports.
* House prices jumped last month, rising 3.5 per cent to an average $324,000, a record.
* Net immigration remains well ahead of long-term average rates for New Zealand.
Reasons for caution
* Pessimists still outnumber optimists among businesses.
* Retail sales in the September quarter were up only 1 per cent on a year earlier in real terms.
* The trade and current account deficits are at unsustainable levels and testify to unbalanced growth concentrated in spending, rather than earning.
* The jump in house prices followed a poor four months and house price inflation is dipping.
* Immigration tends to boost the demand supply of the economy sooner than the supply side, adding to inflation pressures.
