"Houses have been scarce at a time that demand was strong. The reverse is now evolving – with housing building at record levels at a time that population growth is static."
The Reserve Bank expects to see house prices ease over the medium term as a result of this change.
"This means house prices would be moving back toward a more sustainable level – a level that can be explained by underlying economic fundamentals."
Last month the Reserve Bank increased the official cash rate for the first time in seven years moving it from 0.25 per cent to 0.5 per cent.
Mortgage rates have been on the rise for months and yesterday the loan to value restrictions on banks increased with banks only allowed to do up to 10 per cent of new mortgage lending to owner-occupiers with a deposit of less than 20 per cent.
Orr said the move towards more sustainable house prices would be incentivised by slowing demand – as an outcome of higher interest rates and low population growth, and an increase in space to build.
"The recent Government announcements on reducing urban building restrictions is significant in terms of adding to the 'space to build'."
Orr said its work to limit risky mortgage lending was more about limiting the damage to bank's balance sheets rather than altering overall demand.
He said there also needed to be more encouragement for diversification in investment.
"Why would you put all your money on one horse – housing – when backing your retirement?"
Orr said there was no "silver bullet" or one agency that could fix high house prices or housing affordability issues.
"House prices and housing affordability are affected by both supply and demand factors, ranging across immigration, tax policy, government benefits or transfers, land availability, building standards, infrastructure, and training programmes.
"It is access to land and space that remains the biggest challenge to ensuring a smooth functioning housing market."
