The Reserve Bank is keeping an eye on the housing market, threatening to roll out stricter loan-to-value restrictions (LVR) or "additional tools" if prices keep escalating.
The bank on Wednesday released its latest financial stability report, the first since the Government told it to take house prices into account when setting monetary policy.
Issued every six months, the latest report notes "the impact of low global interest rates resulting in increased risk taking and higher asset prices" in the wake of the biggest financial shock in a century - COVID-19.
"This is an international phenomenon, with the New Zealand impact most visible in higher house prices," the bank said.
Deputy Governor Geoff Bascand said borrowers taking advantage of low-interest rates by taking on huge debts are "more vulnerable to a rise in mortgage rates" and are exposed to a market downturn.
"We will be watching how market conditions respond to the Government's recent policy changes. If required, we are prepared to further tighten lending conditions for housing using LVR requirements or additional tools that we are assessing."
From this week, almost all new loans to investors need to be less than 60 percent of the property's value, and less than 80 percent to owner-occupiers. Nonetheless, "households continue to invest a large share of their wealth in houses", the report notes.
"Supply constraints - including land-use restrictions and barriers to the provision of infrastructure - have seen increased demand for housing translate into higher rents and house prices.
"While supply remains constrained, construction activity has increased and is expected to remain high. With border restrictions reducing migrant inflows, new housing supply is starting to outstrip population growth."
This makes present record-high house prices "less sustainable than before" - as the economy improves and inflationary pressures kick in, the Reserve Bank might look to raising interest rates, leaving big borrowers in big trouble.
Over the next four years, landlords will be progressively stripped of their ability to write off interest costs, bringing them into line with owner-occupiers.
"When eventually interest rates do eventually go up, there is now a risk investors could actually sell up in that instance, because it now comes with a tax increase," ANZ chief economist Sharon Zollner told The AM Show on Wednesday morning, ahead of the report's release.
The report says the Government's directive to consider house prices wasn't a problem for the Reserve Bank, because "unsustainable asset price growth can lead to a sudden correction in prices, which would have negative implications for the financial system and the broader economy".
"Housing equity makes up about half of household net worth, and mortgage lending 62 percent of total bank loans."
A graph included in the report illustrates just how quickly house prices have gone up in the last year. It shows how much of a household's annual income is required for a 20 percent deposit on a median-priced home; it's around 140 percent from 2009 until 2014, then creeping up to about 160 percent over the next five years. In 2020 it goes from just over 160 percent to more than 220 percent.
The rest of the economic system has held up well over the last year, the Reserve Bank said, thanks to "Government support and strong capital and liquidity buffers", "but further resilience is needed".
"Successful public health measures along with substantial monetary and fiscal policy support, helped to prevent many business failures and a larger rise in unemployment," said Governor Adrian Orr.
"Key New Zealand export prices have also been resilient, with dairy prices at their highest level in several years. Yet, despite doing better than feared, border restrictions, supply chain disruptions, and social distancing have reduced activity in affected sectors, and some businesses remain vulnerable."
Insurance companies have "maintained or improved their capital positions" in the past six months, and "solid profitability and dividend restrictions have allowed banks to build their capital levels, providing a buffer to absorb any future losses".
From July 2022 banks will be required to have more capital on hand, further protecting them in case of trouble.
