Interest Rate Outlook for June

AltMay was an extraordinary month for the housing market as the Reserve Bank and the Government finally decided enough was enough in Auckland, although the jury is out on whether it will make a difference.

After yet more signs that prices were flying away in the City of Sails, the Reserve Bank announced new LVR restrictions on rental property investors in Auckland and the Government announced a new 'bright line' test aimed at taxing the capital gains of investors who sell within two years. Their 'pincer movement' was launched within a 10 day period and culminated in the Government's surprise pre-Budget announcement of what some are calling a 'Claytons' Capital Gains Tax.

It began at the end of April when the Reserve Bank adopted an easing bias, confirming the growing speculation that very low inflation and the strong New Zealand dollar would eventually force the central bank to cut interest rates. But it only did that after calling in a speech for the Government to reduce the tax incentives for property investors and a warning it would do more itself to slow lending to Auckland rental property investors.

The pressure ramped up massively on May 5. Firstly, Auckland's Barfoot and Thompson reported median house prices rose more than NZ$1,000 a day in April and that twice as many houses sold for more than NZ$1 million than sold for less than NZ$500,000. Then on the same day, Deputy Mayor Penny Hulse announced that Auckland had suspended approving new Special Housing Areas in Greenfields because it wanted the Government to help pay for water, transport and roading infrastructure.

The combination of record high net migration, restrictions on new housing supply, falling interest rates, no foreign buyer restrictions and growing speculative pressure proved too much for the Government. We now know that within days it accelerated plans to toughen its policy for taxing capital gains by property traders.

Just over a week later, the Reserve Bank delivered on its warning when it announced rental property investors in the Auckland Council 'Super City' area would only be able to borrow up to 70% of a property's value. However, realizing that Auckland had accelerated away from the rest of the country, the Reserve Bank eased its 'speed limit' on lending with an LVR of over 80% to 15% of new lending from 10%. The above-80% lending limit remained at 10% for owner-occupiers in Auckland.

The Reserve Bank was concerned about a surge this year in rental property investors buying in Auckland with LVRs of 70-80%, which it said increased the risks to financial stability if prices in Auckland were to suddenly slump. The Government amplified the response from Wellington on the Sunday before the Budget when Prime Minister John Key told a National Party conference in Lower Hutt that rental property investors would have to declare their IRD number to Land and Information New Zealand with every sale and purchase. The IRD would then assume if they sold a property within two years that they were doing it for speculative capital gain, and would tax those capital gains at regular income tax rates.

Key denied this 'bright line' test was a type of new capital gains tax, arguing it simply toughened the existing situation by removing any uncertainty around investors who disguised their intentions when buying and flicking properties. More importantly, the Government is also forcing non-residents to open bank accounts and obtain IRD numbers here, as well as declare their passport details and their home tax details so the information can be shared with their home tax authorities. A withholding tax on realized capital gains within the two-year 'bright-line' period is planned for these non-resident investors from mid-2016.

To emphasise the coordinated approach, both the new LVR restrictions and the 'bright line' test apply from October 1.

But will the 'pincer movement' squeeze prices or volumes?

Opinion is divided on whether the joint move to restrict lending to rental property investors and toughen the rules around taxing trading income will have much impact in Auckland specifically, and nationwide.

Some landlords and real estate agents argued it would have little impact because the measures did nothing to increase supply or restrict foreign demand. It has also done nothing to change fixed mortgage rates, which continued to fall through May in anticipation of cuts in the Official Cash Rate. Some economists are forecasting the OCR will be cut by 50 basis points to 3% as soon as the end of July.

However, the LVR restrictions may have more impact than some think, and quite quickly, just as the original October 2013 restrictions had a bigger than expected initial impact. The Reserve Bank released data in the third week of May showing investor lending in the now-banned 70-80% LVR band totaled NZ$16.3 billion nationally over the eight months to March, which was 43% of all new lending. The central bank warned banks to comply with the spirit of the new rules immediately, even though it applies from October 1.

The other point of the 'pincer' that may hit demand is the requirement non-residents declare their home country tax and passport details. The Government also warned non-residents it would share that information with their home country authorities. China is currently hunting economic fugitives who have invested overseas and has asked New Zealand, Australia and the United States to help track down both people and their assets.

The bottom line

• Auckland's house prices rose 18.9% in April from a year ago, but the joy was not nationwide. Wellington prices fell 2.8% and Christchurch fell 0.6%, although the rest of the North Island was up 3.2% and the rest of the South Island was up 7.0%.

• Most economists now expect the Reserve Bank to cut the Official Cash Rate by as much as 0.5% to 3% by the end of the year as inflation remains well below the bank's 2% target. Average advertised one year mortgage rates fell another five basis points in May.

• The Reserve Bank banned Auckland rental property investors from borrowing more than 70% from October 1, but eased its LVR speed limits outside of Auckland.

• The Government imposed a 'bright line' test for taxing capital gains by investors trading property within two years. The rule does not apply to the family home, deceased estates or relationship settlements.

Source - Bernard Hickey NZFSG News


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