New Zealand restricts mortgages
Global Investor Report - Monthly News for Global Investors 22 May 2015

There has been a lot of commentary about the heady heights of the Sydney residential property market with action calls to cool it down. This has been echoed by rate cuts issued by the Reserve Bank of Australia. You may not be aware that across the Tasman, the residential real estate market in New Zealand's largest city Auckland has also been overheating with house price inflation in excess of household income growth. The Reserve Bank of New Zealand (RBNZ) has taken the further step of placing lending restrictions on real estate investors to try and cool the pricing pressures on the market.

The RBNZ in its May 2015 Financial Stability Report5 "...believes additional temporary measures are required to help contain rising housing market imbalances in the Auckland region, which continue to pose a threat to future financial stability". As such borrowers will be required to hold a minimum 30 per cent deposit on property in the Auckland Council area from October this year - "a speed limit on such loans at close to zero".

Chinese investors are often accused of being the principal cause of rising house prices in Sydney. In the same vein, investors are the major source for demands on Auckland's property market with one third of new lending attributed to such investors over the last half year. Ray White Real Estate has previously been quoted as saying that more than half its Auckland business has come from high net-worth resident and non-resident Chinese and Chinese investment companies over the last year.

A weaker New Zealand dollar, looser currency controls in China, and a general consciousness of New Zealand in the minds of Chinese investors have all been factors in the interest in the Auckland market.

In October 2013 the RBNZ put a "speed limit" of 20 per cent on new mortgages to try and cool the market. But house prices have continued to rise in a low interest rate environment which like Sydney includes a lack of supply and high inbound net migration. To meet the demand in new housing, the new restrictions will not be applied to new build houses and apartments.

The RBNZ sees the restrictions as a pre-emptive strike in protecting the general economy from future shocks. The Reserve Bank believes that the financial system as a whole is sound with liquidity buffers and capital held by lenders increased over recent years and a reduction in the number of impaired assets.

The issue that will come out of these measures is the nature of the investment market, i.e. do the investors, and specifically foreign investors use domestic mortgages? The issue with the restrictions may be that an imbalance arises between local buyers that are unable to obtain a mortgage due to the restrictions on deposit values, particularly first home buyers, versus foreign investors that may pay for a property asset in full or finance their acquisition off-shore, and as such, not only increase an imbalance in ownership, but also maintain the current price increase levels.

Oh Canada

Canada has been a good performer in economic terms since the end of the global financial crisis. The Canadians managed to recover all employment losses made during the recession in just over 2 years, against the 6.25 years it took the United States.

One indicator to give an overview of the economy is the company insolvency rates which fell at an average annual rate of 8 per cent from 2000-12, and at 2 per cent in 2013 and 2014.

However, even though only 10 per cent of Canada's economy is exposed to hydrocarbon extraction (a small figure made all the notable due to Canada having the third largest volume of oil reserves in the world after Saudi Arabia and Venezuela), the apparent historic correlation between GDP and the price of oil suggests that the recent fall may impact the overall economy throughout the ongoing year.

So what is it exactly that might make Canada so susceptible to the oil price? First and foremost oil based exports have seen 38 per cent decrease since June 2014. This has been slightly offset by the weak Canadian dollar which has reduced the non-oil product trade deficit by 13 per cent. Capital expenditure in the oil and gas sector has also seen a huge decline. Some economists are equating this to a 25 per cent drop in CAPEX, or 0.3 per cent of 2015 GDP.

Additional factors such as fiscal contraction in energy dependent areas such as Alberta, as well as a decline in house prices and housing activity will add further pressure. Alberta, as an example, is home to around 20 per cent of Canada's housing activity. In the event that mortgage defaults should gain momentum then the house buying market would become constrained.

Employment in oil drilling accounts for a fraction of the overall population, but the jobs are well paid, and so they have a disproportionate effect on the numbers. In 2015 the Canadian Association of Oilwell Drilling Contractors has suggested a cut of 23,000 jobs. This may be just 0.1 per cent of all employed Canadians, but with higher earnings (around 3x) this could equate to 0.3 per cent of aggregate household income.

It may not all be doom and gloom. The oil markets are seeing a price rebound, so from the perspective of production costs, more jobs can be retained going forward. Though ironically, the end of 2014 and start 2015 reduction in the oil price was good for consumer spending (a reduction in petrol prices gave a 0.9 per cent lift to GDP in the last year). Thirdly, as a result of the aforementioned drop, other sectors such as the chemical industry saw lower fuel costs and as such their own production costs remain low giving them a welcome boost. Fourthly, the Canadian dollar has fallen against the US dollar making exports, whether they be in the chemical sector or other industries, much more competitive.

Finally, for the Canadians, it may be their neighbours that have the biggest impact on their economy. Around 20 per cent of Canada's economic activity relies on exports to the United States6. With the fall in petrol prices at the US pumps, the US consumer is experiencing an increase in disposable income of around 0.5 per cent of GDP (that is roughly US$1,000 per family per annum7). The extra spending power can only go to give Canada's economy a welcome raise.

So where the IMF has forecast that Canada’s real gross domestic product will grow by 2.2 per cent in 2015 and 2.0 per cent in 2016 in its spring World Economic Outlook, the projections are only lower by 0.1 per cent from its earlier forecast of January. In addition, Canadian growth has been described by the IMF as “solid,” citing the aforementioned “stronger” US recovery and the fall in value of the Canadian dollar8: all in all, not a bad outlook really.

What is Brexit?

A new Conservative Government in the United Kingdom may be welcome to some, a reason for remorse for others, but what does it actually mean for the UK and the wider financial community.

One notable manifesto promise of the Conservative Government is a promise to call for a non-binding referendum as to whether the UK should remain a part of the European Union. Public opinion polls vary (and whether they can still be trusted after failing to predict the General Election result) but they have indicated that if such a referendum was held, the British would vote in favour of an EU exit (the 'Brexit' scenario).

The problem for the politicians is this, while they have appeased the public by promising such a vote they leave business and the financial markets exposed to volatility, in particular businesses that trade within the EU, and UK and European bond, equity and currency markets. The stock markets initially reacted well to a Conservative win (being the party that typically supports business) but will the realisation of the 'Brexit' referendum put a dampener on activity? Overall, there may be instability between the British Pound, the Euro and other currencies such as the US and Australian dollar.

A lot of gripe from the British is around the expense of the bureaucratic machine that is the EU and the perception of unnecessary control and regulation over British affairs. While there is a sound argument for the UK not to leave the EU, it may be that the UK could follow a Norwegian or Swiss model by renegotiating terms with the EU that allow citizens to move freely within the EU and for business to trade freely with their EU counterparts. This would potentially remove the EU's control over matters such as the supremacy of the Westminster parliament and English and Scottish courts, but as Swiss financial institutions have come to learn, it would not necessarily put British financial institutions out of reach of regulators and tax authorities across the continent.

British financial institutions and businesses may end up in the same boat as they were while in the Union. This of course depends how successful the new Conservative government is at negotiating terms that favour the UK. One help to the Government, much like Norway and Switzerland, is that it does not have to detangle itself from the Euro currency.

Overall the last five years of Conservative coalition rule have been good for the economy and the financial services sector. The Government has to date been a supporter of enterprise and new business, setting up initiatives such as Level399, Europe's largest technology accelerator for finance, retail, cyber-security and future cities technology companies.

But as with Sydney, and it would seem Auckland, London now has to consider house price growth, with roughly 40 per cent net migration to the capital, and talk of initiatives by London Mayor (and newly elected Member of Parliament) Boris Johnson calling for an unrestricted immigration agreement between Australia and the UK.

Best regards,

Martin Barry
Vice President,
Chief Wealth Management Officer

     
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5. http://www.rbnz.govt.nz/financial_stability/financial_stability_report/fsr-may15.pdf
6. http://www.census.gov/foreign-trade/index.html
7. http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm
8. http://www.imf.org/external/pubs/ft/weo/2015/01/pdf/c2.pdf
9. http://www.level39.co/
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