by Susan Edmunds
He made a speech in Canterbury today, after his announcement yesterday that the Official Cash Rate would remain at 2.5%.
He made it clear yesterday that he expected to start increasing rates soon.
But he indicated today that he was already looking to challenges that could lie ahead once the economy hits the middle of the cycle.
New Zealand’s economy had grown faster than comparable economies overseas over the last two years, and achieving price stability would help ensure that this expansion is sustainable, he said.
He seemed particularly concerned about what could happen if there was a significant correction in over-valued house prices. This risk was exacerbated by high levels of household debt, he said.
“The risks that the housing market pose to financial stability and the broader economy were a major reason for introducing speed limits on high loan-to-value ratios for residential mortgages last year,” he said.
``While a substantial fall in New Zealand house prices is unlikely, such a fall could happen if there was a marked deterioration in the household sector's ability to service its mortgage debt due to a sharp rise in unemployment, falling incomes, or very high domestic interest rates,'' Wheeler said. ``A sharp correction of the type seen in several advanced economies in recent years would likely be accompanied by a domestic recession.''
He said that early indications were that the new loan-to-value restrictions had prompted housing turnover and the rate of house price inflation to ease. But he said that could also be due to a range of other factors, such as affordability.
Inflationary pressures were beginning to appear particularly in the construction sector, where resources were being reallocated to tackle the Christchurch rebuild and the lack of construction in Auckland, he said.
While an elevated exchange rate had kept a lid on tradable inflation, prices in the non-tradable sector were expected to accelerate as the labour market tightened and capacity was reduced, he said.
``If actual inflation and expectations of future inflation were to rise significantly, competitiveness and real income growth would decline. The bank's subsequent efforts to maintain price stability by raising nominal and real short term interest rates would be more disruptive, the further inflation was allowed to deviate from target.''
Recent economic indicators showed stronger growth and inflation over the past six weeks than the central bank had built into its December projections. Wheeler said that, as well as the moderating housing market, would be captured in the bank's next update to its forecasts in March.
``The exchange rate remains a considerable headwind for the economy, and the bank does not believe its current level is sustainable in the long-run,'' Wheeler said. “The Bank would like to see a lower exchange rate."
He said a sharp drop could not be ruled out and would intensify inflation concerns.
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