A spreading housing crisis and the prolonged slump in dairy prices have increased risks to New Zealand's financial stability over the past six months, the Reserve Bank of New Zealand warned Wednesday.
And while New Zealand's economic growth remained "solid," growth in some trading partner economies was slowing, compounding domestic problems, according to the RBNZ's six-monthly Financial Stability Report.
"Dairy prices remain low with global dairy supply continuing to increase. Many farmers now face a third season of negative cash flow with heavy demand for working capital," RBNZ governor Graeme Wheeler said in a statement on the report.
House price inflation was lifting again in Auckland - the country's largest city and home to a third of the population after cooling in late 2015 and early 2016 following lending restrictions and government measures introduced in October last year.
House prices had also begun increasing strongly in a number of regions across New Zealand.
The RBNZ remained concerned that a future sharp slowdown could "challenge financial stability" given the large exposure of the banking system to the Auckland housing market.
Further efforts to reduce the imbalance between housing demand and supply in Auckland remained essential, said Wheeler.
RBNZ deputy governor Grant Spencer said the banking system also faced challenges with upward pressure on the cost of funds from abroad for New Zealand banks.
"The level of problem loans in the dairy sector is expected to increase significantly over the coming year, although we expect that dairy losses will be absorbed mainly through reduced earnings," Spencer said in the statement.
The RBNZ was also closely monitoring the proportion of risky housing loans on bank balance sheets to assess whether further financial policy measures would be appropriate.
Analysts said the risks caused tension in the RBNZ's ability to cut interest rates in order to raise inflation into its target range of 1 percent to 3 percent and to deal with an overvalued New Zealand dollar.
An economic note from the ASB Bank Wednesday said the RBNZ would probably slow the pace of cutting its official cash rate - currently at 2.25 percent- but it still expected cuts of 25 basis points in June and August.