The housing market has been easing since its peak in late 2003 and is expected to continue to ease over the next year, with average house prices declining 5% in the year to mid-2007. The increase in housing wealth has provided a stimulus for consumption growth recently thanks to the increase in households net assets, some of which has been used to fund current consumption. The slowdown in house price growth is expected to restrain growth in expenditure.
In addition, households may wish to consolidate their debt in order to help control debt servicing costs. This implies a small decline in the level of household dis-saving. Lower growth in residential construction (discussed below) will also reduce private consumption, especially for consumer durables which are associated with investment in housing. (See the box on Consumption and Housing Wealth on pages 72-73 for further discussion.)
Conditions in the labour market are expected to ease in the forecast period, with a slight decline in employment in the year to March 2007. The decline in hours worked will be more pronounced as some employers hold on to existing labour but reduce their hours. Growth in hourly earnings is expected to decline to 3.5% in March 2008 from its peak of 4.7% in mid-2006. The combined effect of these changes is that annual average growth in compensation of employees will decline from 7.7% in the third quarter of 2005 to 3.0% in March 2007, before recovering to 4.2% in March 2008 and 5.2% in March 2009. (See pages 75-76 for more discussion of the labour market.)
Population growth has been slowing since net permanent and long-term (PLT) migration inflows peaked at 42,500 in mid-2003. Net PLT migration inflows have already increased from a low of 6,000 in the year to October 2005 to 9,700 in the year to March 2006 and are assumed to be around 10,000 per annum for most of the forecast period. However, there is some uncertainty about future migration flows. Higher-than-forecast departures and decreasing arrivals are possible as economic growth in New Zealand slows relative to other economies. Such an outcome would pose a downside risk to our forecasts.
Figure 1.11 Permanent and long-term migration annual totals
Sources: Statistics New Zealand, The Treasury
The fall in the New Zealand dollar, which commenced in the first quarter of 2006 and is expected to continue, will raise the cost of imported goods, reducing consumption levels. Furthermore, over the past couple of years consumers may have brought forward their expenditure on some durables to take advantage of lower prices coming from the high exchange rate. As a result, some expenditure which would have occurred over the next couple of years may have already been undertaken, and so consumption growth is likely to be lower than otherwise. In addition to higher prices for imported goods, the prices of locally produced goods may also rise because of increases in the price of imported inputs or imported substitutes, leading to lower real incomes and slower consumption growth.
Further out, the decline in the New Zealand dollar is expected to lead to higher export returns which will flow through to higher household incomes. Along with lower interest rates and increasing employment, these higher incomes are expected to lead to an increase in private consumption growth on a quarterly basis from mid-2007. On an annual average basis, private consumption growth is forecast to strengthen from 0.8% in March 2008 to 1.9% in March 2009.
Increases in housing wealth have been an important factor in explaining strong consumption growth in the past five years, but are expected to make a smaller contribution in the forecast period.
Over the past five years, growth in real private consumption has been an important contributor to overall economic growth. Over that period, private consumption has grown at an average annual rate of 4.6% to be 25.4% higher than in 2000, while real GDP has grown at an average annual rate of 3.5% to be 19.0% higher than in 2000. A number of factors have combined to support this strong consumption growth and these include: a strong labour market with rising employment and falling unemployment, as well as relatively strong wage growth; a currency that has generally been appreciating or at a high level contributing to lower prices for imported goods; boosts to population from net migration, particularly over 2002 and 2003; and interest rates that have been relatively low by historical standards.
In addition, households have experienced substantial wealth gains from the boom in property prices that has occurred over the last few years. This boom has itself been supported by many of the factors outlined above, but has also been a more widespread phenomenon with rapid house price growth occurring in a number of countries. Since the end of 2000, New Zealand house prices have increased by nearly 80% and, with housing assets by far the largest asset class held by households, this has resulted in a surge in both net housing wealth and the overall net wealth of households.
The nominal value of housing assets held by households increased by 118% between December 2000 and December 2005 with households now holding just over $500 billion worth of housing assets.6 Over the same period mortgage values have increased by 83%. Nominal net housing wealth (housing assets less mortgages) has increased an estimated 131% in five years (deflation based on changes in consumption prices results in a 118% real increase).
Figure 1.12 – Housing wealth
Source: Spicers
Studies suggest that consumption is positively related to changes in real housing wealth, at least in the short run, and while it is difficult to be precise about the exact magnitude of the relationship – several estimates suggest that a 10% increase in real housing wealth generates around a 2% increase in consumption.7 While such estimates are possibly too large in times of rapid house price growth and therefore housing wealth accumulation, there is evidence that households have been utilising some of their housing wealth gains to fund consumption by borrowing against the equity in their housing. Simple estimates of mortgage equity withdrawal, the extent to which new mortgage borrowing exceeds expenditure on residential investment, suggest that at an aggregate level such withdrawals totalled $13-14 billion over the past three calendar years.
While house price growth and its associated wealth effects have been important factors supporting consumption growth over recent years, their influence is expected to become much less pronounced over the forecast period as the rate of house price growth slows and even becomes negative. From the end of 2005, nominal house prices are forecast to increase only 4% over the entire forecast period (up to June 2010).
Figure 1.13 House prices and consumption
Sources: Statistics New Zealand, QVNZ, The Treasury
Factors behind this relatively slow price growth include: slower population growth limiting demand for housing and an expected increase in housing vacancy rates; a return toward longer-run relationships between house prices and rents, with movements in house prices expected to stop diverging from rents and begin converging; and slower household income growth than has occurred over 2004 and 2005 acting as a constraint on the amount by which house prices can increase without affecting affordability and also limiting the extent to which higher rents can contribute to closing the gap between rental and house price inflation.
Residential investment is estimated to have declined 5.4% in the year to March 2006, following a weak September 2005 quarter. Many of the same factors explain this decline as those discussed above in relation to the slowing in private consumption, in particular the impact of past interest rate increases and lower population growth as a result of lower net immigration. Residential investment is forecast to decline further in the March 2007 year as a result of a continuation of these factors. These influences are reflected in building consents data which point to weaker residential construction activity in the near term. Expectations of slower house price growth will also affect residential investment.
Figure 1.14 – Growth in residential investment
Sources: Statistics New Zealand, The Treasury
Figure 1.15 House sales and dwelling consents
Sources: Statistics New Zealand, REINZ
The housing market has been slowing since late 2003, despite a revival in late 2004 as a result of the “mortgage wars”. The slowing is a result of the same fundamental factors as the fall in residential investment, plus some others related specifically to the housing market. Rents have not kept pace with the increase in the capital cost of housing, indicating that the return on investment is not sufficient to cover the cost at current values. In addition, estimated vacancy rates have been increasing, suggesting that the supply of housing is outstripping the demand for additional units. Furthermore, the price of existing housing relative to the cost of building new housing is at all-time highs; however, rather than suggesting that more new housing needs to be built, this factor points to the overheated nature of the second-hand housing market.