New Zealand central bank flags inflation risks, financial system sound

© Reuters. FILE PHOTO - Cranes located on construction sites are seen near high-rise residential apartment buildings in central Auckland, New Zealand, June 25, 2017. REUTERS/David Gray

WELLINGTON (Reuters) - New Zealand's central bank warned on Wednesday that growing global inflationary risks could lead to higher interest rates and declines in asset values.

In its bi-annual Financial Stability Report, the Reserve Bank of New Zealand (RBNZ) said the country's financial system remains resilient in the face of COVID-19.

But it noted that more persistent inflationary pressures and any increase in inflation expectations, coupled with weaker growth, could lead to a sudden tightening in financial conditions.

"With the risk of global inflation heightened, already stretched asset prices are facing headwinds from rising global interest rates," RBNZ Governor Adrian Orr said.

New Zealand's Consumer Price Index (CPI) has surged, while the unemployment rate hit a record low on Wednesday, prompting market talk of a further interest rate hike when the RBNZ meets on Nov. 24.

New Zealand raised interest rates for the first time in seven years last month and signalled further tightening to come..

Orr said labour market and other data were "highly volatile", but the underlying trend was clear.

"The COVID-19 economic shock has had a significant impact on the supply side of the economy as well as on demand. We are seeing a strong demand for all resources at a time when the ability to meet that demand is challenged," Orr told a media conference.

HOUSING CORRECTION

The RBNZ said house prices are above their sustainable level, increasing the chance of a correction.

Homes in New Zealand are the most unaffordable among OECD nations, with prices soaring about 30% in 12 months due to an acute housing shortage, historically low interest rates and cheap access to capital from the government's pandemic-driven stimulus spending.

Orr said supply of space and land for housing was the main driver for house price volatility.

The bank will start consulting this month on the implementation of debt servicing restrictions to address housing risks, but said lenders would need around 6 months to bring these in once they had been designed.

It will also increase the minimum core funding ratio (CFR) requirement for banks to the previous level of 75% from January. The CFR was reduced to 50% in April to give banks more flexibility to manage funding during the pandemic.