2 Nov 2022

Reserve Bank warns rising interest rates and unemployment will test NZ’s financial resilience

11:34 am on 2 November 2022
Assistant Governor of Reserve Bankr Christian Hawkesby.

RBNZ deputy governor Christian Hawkesby said there were growing risks to the global economy and despite government finances being in good shape, New Zealand was not immune. Photo: RNZ / Dom Thomas

The Reserve Bank says a significant jump in unemployment would present the biggest risk to New Zealand's financial stability, but the country's financial system remains resilient.

In its half-yearly financial stability report, the central bank said while the financial system as a whole remained sound, some households and businesses would come under pressure from rising interest rates.

Negative equity and mortgage arrears were not widespread despite house prices falling 11 percent from their November 2021 peak, the RBNZ said.

However, it warned they would grow if prices continued to fall and mortgages were repriced to higher interest rates.

"Significantly higher unemployment would lead to further stresses among households, and is the biggest risk to financial stability at present."

The bank said a sharp increase in jobless numbers amid worsening economic conditions "could lead to widespread defaults and significant losses for the banking system".

Household spending will be limited by rising debt servicing costs and falling wealth, and current conditions would likely lead to a fall in new residential construction once existing projects were completed, it said.

In spite of the challenges, New Zealand's financial system remained "well placed to support the economy in the face of a rising rate environment", the bank said.

"Banks' capital and liquidity positions are strong, and profitability and asset quality remain high. Recent stress tests demonstrate banks' resilience to scenarios involving rising unemployment and interest rates, and declining house prices."

But the RBNZ warned of the stress that households and business faced.

It said it was important that financial institutions took a "long-term" view amid the economic uncertainties, making "prudent lending decisions", keeping credit access open and supporting customers in stress.

"Imbalances persist" despite falling house prices

The Reserve Bank said house prices had fallen by 11 percent from the November 2021 peak for the country as a whole, with Auckland prices falling 15 percent and Wellington 18 percent.

"In spite of the fall in prices so far, rising interest rates have meant that the debt servicing burden for new buyers remains at a historically high level.

"Furthermore the removal of tax deductibility on interest expenses substantially worsens the cash flows generated by investment properties at high levels of gearing," it said.

The RBNZ expected house prices to continue to fall towards "more sustainable levels" in the near term as demand for housing falls and mortgage rates rise.

It said a sharp fall from current levels remained a possibility.

"Distressed sales, which have yet to be a large factor in the current downturn, could also reinforce further price declines alongside general negative sentiment."

New Zealand not immune from global risks

The Reserve Bank said the rapid rise in interest rates over the past year presented a headwind to global economic growth.

"A severe downturn in any of New Zealand's major trading partners would lead to reduced demand for our exports, in turn lowering incomes of households and businesses, and leading to losses on banks' lending," it said.

China - New Zealand's largest trading partner - has faced a slowing residential property sector, and together with its zero-Covid strategy contributed to slower economic growth.

"We continue to monitor financial stability risks in China and their potential impact for New Zealand. Chinese authorities will likely act in the event of a financial stability crisis and hold extensive assets and foreign reserves to do so," the RBNZ said.

External demand for New Zealand's exports remained robust, but a fall in growth and household consumption in the main trading partners could weaken demand for New Zealand's exports, it said.

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