New Zealand interests rates are set to soar if new restrictions on high loan-to-value mortgages fail to curb the country's overheating housing market, the head of the Reserve Bank of New Zealand (RBNZ) warned Thursday.
The official cash rate was projected to rise by 2 percentage points from its historic low of 2.5 percent, where it has sat unchanged since March 2011, over the period from next year to 2016, RBNZ governor Graeme Wheeler said in a commentary on the RBNZ website.
"This could result in interest rates on first mortgages of 7 to 8 percent. If the loan-to-value speed limit is unable to slow house price inflation, larger increases in the official cash rate would be required," he said.
Wheeler was defending the RBNZ's move this month to restrict banks to lending no more than 10 percent of their mortgages to people with deposits of less than 20 percent of the value.
Critics have said the restrictions have locked many first-home buyers out of an already expensive market, and the main opposition Labour Party has pledged to exempt first-home buyers from the restrictions if it is elected next year.
"Our concern is that excessive increases in house prices in parts of the country, if unchecked, pose increasing risk for the financial system and the broader economy. High and rising house prices increase the risk and potential impact of a major correction in house prices, and consequential loss to lenders. In a severe downturn, such losses would be expected to significantly reduce banks' willingness to lend," said Wheeler.
New Zealand house prices were expensive, based on international comparisons, and household debt levels relative to disposable income, which had doubled over the past two decades, were also very high, said Wheeler.
In the United States, the median real net household wealth fell by 39 percent from 2007 to 2010, and a quarter of U.S. mortgage holders owed more on their homes than what the homes were worth.
While a sharp fall in New Zealand house prices was not anticipated, the economy was not immune to such risks.
"The world economy still faces major challenges and, if global growth slows markedly, or if China's financial system experiences major difficulties, it would quickly feed into the New Zealand economy and housing market," he said.
House prices were rising rapidly in the two biggest cities of Auckland and Christchurch because of housing shortages and easy credit and restricting lending to borrowers with low deposits would help reduce the upward pressure on prices.
The RBNZ had ruled out applying the restrictions regionally and exemptions for buyers of cheaper homes as they would just shift pressures to new areas or to certain types of housing.
The restrictions would be lifted when there was "a better balance in the housing market" and less risk or renewed high house price inflation.