Policy makers and regulators alike have stepped up to contain systemic risk in the financial system, but it’s still too early to know if this saga is near being contained, or if further wobbles are yet to come, commentary in the ANZ Bank’s latest Property Focus.
“Whether or not the current situation significantly worsens depends on whether we see wobbles among globally systemically important banks, and/or if these events lead to a broader shock to confidence in the financial system,” says Sharon Zollner, ANZ’s chief economist.
For New Zealand housing, the potential impacts of these events stem largely from two channels: the direct and indirect impacts on credit conditions, and the direct and indirect impacts on the real economy - with plenty of overlap between the two.
But there are many moving parts and potential offsets, depending on the magnitude of the shock – which is still unknown, says Zollner.
Credit conditions: Housing and residential construction sit at the more interest-rate-sensitive end of the spectrum.
It’s not just the OCR that determines credit conditions for these and other pockets of the economy, says Zollner.
“Changes in the pricing of risk can move the dial, and global financial market wobbles can be the catalyst for adjustment, impacting not only domestic risk perceptions, but also the ‘risk premium’ a small open economy tends to acquire when it’s flapping in the winds of global markets.”
She says in reality, risk is priced across many different dimensions, such as specific business risk, financial risk, exchange rate risk, liquidity risk, and other country-specific risks, such as a country’s net external position. Another way to think about this is that changes in risk perceptions can:
∙ impact the cost that banks have to pay when they source funding to lend to their customers;
∙ impact the availability of that funding - meaning a lower-than-otherwise supply of credit for a given level of demand; and
∙ impact how banks allocate credit, for example, if a certain industry is facing significant challenges to its longer-run viability, banks may not deem it feasible to extend credit to that industry.
“We are now deep within the realm of the RBNZ’s regulatory framework, such as bank capital requirements, which are designed to keep the system resilient through events such as these,” says Zollner.
“There’s no such thing as a free lunch: higher bank capital requirements, for example, can curtail credit allocation to ‘riskier’ projects, and increase bank funding costs – ie, credit is harder to get than otherwise and may come at a higher cost to the borrower.”
New Zealand regulators have decided that’s a cost worth paying, and now, as the global financial system wobbles, the country will hopefully see some benefit via a lower-than-otherwise susceptibility to contagion.
All in all, says Zollner, the credit conditions channel means that for a given level of the OCR, credit conditions may be tighter than otherwise when an adverse financial shock comes along.
This might manifest in higher-than-otherwise interest rates – eg, via higher funding costs, or lower than otherwise credit availability or both.
But what happens if NZ remains relatively isolated from these global events and/or they get resolved relatively quickly without creating a meaningful and sustained tightening in financial conditions?
“In the interim we’re left with interest rates taking longer than they should to get to restrictive levels, possibly meaning that rates need to stay high for longer,” Zollner says.
“So on the one hand, a financial shock, if it is meaningful and sustained, may mean the OCR doesn’t have to do as much work as otherwise, but if the financial shock turns out to be small and, it may mean the OCR has to do more because wage and price setting behaviour has been given more time to get under the fingernails of the economy.
So what does it all mean for the housing outlook?
At this early stage, it could mean nothing, it could be a complete game changer - for both housing and the broader economy - or it could end up being something in between.
Zollner says the bank’s current working assumption is closer to the ‘nothing’ camp, but the ‘somewhere in between’ scenario is looking more and more possible.
“For now, we’re not factoring any impacts into our forecasts, and maintain both our OCR call for a peak of 5.25% come May and our house price assumption for a 22% peak-to-trough decline.
“All up, there simply isn’t enough concrete information in recent developments to move the dial on our housing outlook and the housing market data continue to evolve consistently with our forecast.”
She says, however, there is a growing risk the housing market or the broader economy won’t go the way ANZ expects.
“Whether that’s slightly tighter credit conditions than otherwise - for a given level of the OCR - or something much nastier is yet to be determined.
“Economic cycles don’t tend to end in a soft controlled way, but they also don’t tend to end in a predictable way.”
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