I feel safe in saying that I have satisfactorily proved to myself that accurately predicting where house prices will go both heading into a pandemic and coming out of it is impossible. We all underestimated the extent to which prices would rise when the pandemic struck in early-2020. Now, almost everyone has underestimated the extent to which prices, and sales, are heading down now that the pandemic is over and the inflation resulting from excess stimulus needs to be brought under control.
To understand why average NZ house prices fell 1.7% in December after falling 1.3% in November and strangely rising 0.2% in October we need to note the two big surprises received over a five-week period from October 18 to November 23.
In the middle of October, we learnt that inflation was not comfortably being brought under control as a result of interest rate rises to date. The annual inflation number came in at 7.2% rather than the anticipated 6.6%, and most fixed interest rates for home mortgages rose 0.5%.
Then they rose another 0.5% after November 23 when the Reserve Bank lifted the official cash rate by a record 0.75%, predicted a peak of 5.5% rather than their earlier pick of 4.1%, and said a recession would be needed to get inflation under control.
As a result of the 1% jump in interest rates, expectations by people that they will go higher, and fears about recession, we have seen extremely large declines in both consumer and business sentiment gauges. We have also seen a substantial and new stepping back of buyers from the residential real estate sector because of fears about debt servicing costs and that house prices will fall further.
This strike by buyers means that in seasonally adjusted terms dwelling sales fell over 5% in December and average prices declined by 1.7% as noted above.
It is hard to continue running the argument that we are in the endgame for declining prices when the inflation dynamics have turned out to be vastly different from what we all were expecting.
Where do things go from here?
At some stage the Reserve Bank will feel confident that the deteriorating economic outlook will kill inflation off. They will signal that the tightening cycle is near an end and all attention will turn to when interest rates start falling. When this happens, we are likely to see some substantial falls in fixed mortgage rates for periods of three years and beyond.
But we have proven that we cannot know when this point in the monetary policy cycle will be reached.
Each week will bring us new information which we economists will analyse to try and see if the inflation genie looks like going safely back into its bottle. We were wrong in our analysis last October, so this time around caution suggests we, including the Reserve Bank, will need to see some actual decent falls in inflation measures and not just declines in economic activity now coming through in monthly data releases.
From my own suite of surveys, we have in hand data from my survey of mortgage advisers showing that in the third week of January observations of investor and first home buyers were as weak as in December. No recovery in buyer demand is evident and people are likely to sit on their hands this time, like us economists, until we can be 90% sure that inflation is falling, and the interest rates threat is receding.
Again, we don’t know when this will happen. But for now, it seems safe to assume that the housing market will weaken through to perhaps the middle of the year. Hopefully before then we will have gained confidence about inflation falling and the light at the end of the tunnel will appear for a housing market now into its second year of correcting downward.
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