Rodney’s Ravings: There’s time to prepare for the next house price boom

Guest post by Rodney Dickens

Major upturns and downturns in house prices are largely linked to what the Reserve Bank (RBNZ) does with monetary policy.

This article seeks to explain this link – an understanding of which is critical to making money from housing market cycles – and why the next sustained increase in house prices is probably a few years off.

Interest rates are the major driver of housing cycles (as shown in my regular housing reports) while major cycles in interest rates are linked to inflation and the RBNZ’s OCR decisions.

As a result, the unemployment rate (a good indicator of where inflation is headed in the medium-term) gives us some insight into when the next major upturn in house prices is likely to begin.

The vertical lines in the chart below, show when the unemployment rate peaked in past cycles. You’ll notice there was a double peak after the GFC, which may be relevant this time around.

The scale on the left hand side of the chart is logarithmic, to put the earlier house price behaviour in better perspective.

In these past cycles, major growth in house prices hasn’t started until after the unemployment rate has peaked – and sometimes not until a year or more after the peak.

Currently, our unemployment rate is well below my 4.75-5% estimate of the minimum rate the RBNZ needs to aim for, in order to achieve its inflation target.

In an ideal world, the RBNZ would keep economic growth low for between 2-3 years to ensure an orderly increase in the unemployment rate.

Instead, it’s blindly charging ahead with OCR hikes, without consideration of the fallout in the pipeline; including the likelihood that the fall in residential building activity will be roughly three times greater than the 14% the RBNZ predicts.

The end result will be an earlier and deeper recession than the RBNZ has forecasted.

This will boost the unemployment rate significantly but with a modest lag, and it will cool inflation with a longer lag given how things work. It will be some time before there’s clear confirmation inflation is tamed, even though the RBNZ has probably already tightened too much.

The RBNZ shows no sign of taking these lags into account, just as it is blind to the scale of the fallout from what is probably the sharpest ever increase in interest costs we’ve ever had.

Under Governor Orr, the RBNZ has become more reactive, increasing the odds it will take things further (and longer) than it needs to in the battle against inflation.

As a result, we’re likely to see the unemployment rate ultimately rising above the “neutral” level the RBNZ should aim for.

This will, however, be the basis for the next major upturn in house prices.

Once the unemployment rate overshoots on the upside there will be spare capacity in the economy. This will allow the RBNZ to be growth-friendly for a few years – and, again, probably for longer than it should because of its tendency towards reactive decision-making.

And because major upturns and downturns in house prices are linked around the country, as the chart below shows for some of our major centres, it’s an effect we’ll likely see across most parts of the country.

By Rodney Dickens, Managing Director, Strategic Risk Analysis Ltd www.sra.co.nz.

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