Dollar predicts house prices

If Westpac’s economists are right, those interested in what’s happening to house prices ought to be keeping a close eye on the New Zealand dollar.

Monday, November 15th 2004, 1:18AM

by Jenny Ruth

Bank economists Brendan O’Donovan and Nick Tuffley say that, over the past 20 years, when the currency has been rising so have house prices and vice versa.

They think this may be because house prices are a very good indicator of inflation in the domestic part of the economy and may even anticipate general domestic inflation.

"Given the investment component of housing, prices can be anticipatory and there are strong momentum effects," they say. "Also, pressure in the housing market tends to emerge quicker than in other goods markets due to the fixed nature of supply in the short run exacerbating housing cycles."

And when inflation is rising, the Reserve Bank is raising interest rates which tends to encourage a rising currency.

A rising currency also encourages euro-kiwi bond issuance. A euro-kiwi bond allows foreign retail investors to take advantage of New Zealand’s relatively high interest rates.

That in turn means foreign capital flowing into the country’s banks (who are at the other end of euro-kiwi bond issues) which provides the funding for a housing boom. But this is "an enabler rather than cause of house prices," the economists say.

They were already predicting that house prices are likely to fall 5% on average during 2005 as population growth slows, interest rates rise, new supply becomes available (from the building boom) and sentiment changes.

"This prognosis is well in train with most partial indicators showing the housing market is in decline … if past relationships hold, then this presages a likely decline in the currency."

They are forecasting that the currency will stay strong for about another four months or so but will weaken dramatically from mid next year as the economy slows and it becomes "apparent that inflation will not be the demon the Reserve Bank fears."

That will mean the central bank will start cutting interest rates again.

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