Dawn chorus: Diversionary direction

Grant Robertson tells the RBNZ to 'take housing into account' when setting both monetary policy and financial policy. It's unlikely to lift interest rates, but may lead to DTIs for landlords

TLDR: Morena. Financial markets got into quite a tiz yesterday and last night over Finance Minister Grant Robertson’s formal direction to the Reserve Bank to take the housing market into account when setting interst rates and its bank lending policies. The central bank is unlikely to tighten monetary policy as a result because it would need to hike interest rates to make housing more affordability, which is diametrically opposed to the bank’s main aim of keeping inflation around two percent and helping support full employment.

But the real action is around the Reserve Bank’s regulation of banking lending and capital requirements. The direction is more likely to lead to the introduction of debt to income limits for landlords, but not first home buyers, and some sort of ban or restriction on interest-only mortgages for landlords, which may limit house price inflation a bit. It’s no ‘silver bullet’ and doesn’t involve the Government taking big political risks.

Taxing wealth and proper infrastructure spending still not touched

This direction by the Government to the Reserve Bank is essentially a distraction, perhaps by design, from the real political and financial tasks the Government still needs to address: taxing wealth and/or capital gains, and using Government borrowing to build the pipes, railways, roads, schools, hospitals and especially houses to affordably and healthily house the ‘team of five million’.

The PM’s decision to rule out a Capital Gains or wealth tax ‘in her political lifetime’ in 2019 hangs like a cloud over the Government, along with the determination of Robertson and the PM to repay debt before spending as heavily as it should on infrastructure. Without resolving those issues, it’s hard to see much improvement, particularly when the Government’s definition of addressing affordability just means slowing the rate of inflation from around 20% right now to closer to 5%. It will not allow prices to fall. That means it will still take decades for incomes to catch up with prices. The Government has said it is ‘leaving no stone unturned’. This announcement is more of a small pebble, and the rocks of taxing wealth and building massively remain firmly in place.

A market tantrum

The NZ dollar rose to within a whisker of six-year high of nearly 75 USc and 10 year wholesale interest rates sprinted over 2.0 percent as some investors saw the Government’s move as stopping the Reserve Bank from being able to run loose monetary policy. Bizarrely, traders see chances of a rate hike as soon as February, 2022. Most think that’s unlikely until much later next year.

Our 10 year Government bond yield spurted 18 basis points higher to 1.88 percent, its highest point since April 28, 2019. The 10 year swaps contract rose to over 2.0 percent and wholesale markets began pricing in an OCR hike as early as February next year.

In essence, the markets have delivered the tightening the Government may have wanted to cool the housing market, but it won’t please the Reserve Bank. We’ll see now whether Governor Adrian Orr goes out in the next day or so to tell traders to taihoa on the tightening. He is due to talk in public at the Canterbury Employers’ Chamber of Commerce at 1.10pm this afternoon.

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Hand waving on OCR

In reality, it’s unlikely the Reserve Bank will change its decisions on interest rates, money printing or even the prospect of negative interest rates because of the minister’s decision to include house prices in the Monetary Policy Committee’s remit. The MPC has to focus on achieving its two percent inflation and ‘supporting maximum sustainable employment’ goals. They are diametrically opposed to what it would have to do with interest rates if it was to prioritise ‘sustainable house prices.’

The key point in the Reserve Bank’s statement ‘welcoming the direction’ was this: “The replacement MPC remit, which is effective from March 1 2021, requires the Committee to assess the effect of its decisions on the Government’s policy relating to sustainable house prices.”

The bolding is mine. The Reserve Bank could easily cut interest rates and add commentary to its decision that: ‘this is likely to push up house prices.’ Job done. Effects assessed.


DTIs and interest-only limits

The more interesting part of the directive is around financial policy and what the Reserve Bank forces the banks to do their lending policies. The Reserve Bank has always wanted a Debt To Income (DTI) limit for home buyers, regardless of whether they’re first home buyers or investors. It got Loan to Value Ratio (LVR) restrictions, which were initially applied across the board in August 2013 and hammered first home buyers first and hardest. It eventually tweaked the LVR restrictions a couple of times to allow loans for new builds without restrictions, and to require a 40% deposit for landlords, double the amount needed for owner occupiers. At various points there were specific and tougher rules for Auckland landlords, although they are gone now.

The Reserve Bank also asked the Key/English Government for DTI restrictions in 2016, but was refused because an across-the-board limit of, for example, the 3.5 multiple adopted in Ireland, Britain’s 4.5 times income and Norway’s 5.0 times income, would hurt first home buyers hardest. Reserve Bank figures for up to the end of September show a limit of four would have ruled out two thirds of lending to first home buyers

Robertson made the point in his statement of saying he wanted any DTI limit “to apply only to investors” and for the bank to look at limiting interest-only mortgages, which are mostly used by landlords. “It’s important that any potential restrictions do not disproportionately affect first-home buyers and low-income borrowers,” Robertson said.

Now the challenge for the Reserve Bank will be how to ‘carve out’ first home buyers without appearing to be getting too ‘down and dirty’ inside the banks’ lending departments. The theory is the Reserve Bank’s rules should be mimicking the risks of such mortgages, whereas banks may think that loans to landlords are less risky than first home buyers. It may require the bank to change settings for capital requirements for different types of mortgages, which would force the banks to change the interest rates by different types of loans and borrowers. Currently, mortgage rates are much more ‘commodified’ than in other markets such as Australia, where interest-only and low deposit mortgages to landlords typically have higher rates to reflect the higher risks and capital requirements.

I had a chat with CoreLogic’s Head of Research Nick Goodall yesterday and here’s the Zoom recording of it, which anyone should be able to view. Please ignore the first 25 seconds of faffing around.

The other things to watch out for in the coming weeks and in May’s Budget are ‘demand and supply’ measures from the Government that could include another ramping up of Kainga Ora’s build programme (from the current 18,000 by 2024), an extension of the brightline test from five to seven or 10 years, and restricting landlords from claiming all their interest for tax reduction purposes by using so-called ‘thin capitalisation’ rules that currently apply to some businesses.

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Have a great weekend

Thanks again to Karl on Insta for the pic above


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