UPDATE 1-Housing market, China, rural debt key NZ financial risks -RBNZ

Tue May 13, 2014 6:13pm EDT

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WELLINGTON, May 14 (Reuters) - A stretched New Zealand housing market, debt-laden farmers and a major slowdown in China remain the major risks to the country's financial system, and tight lending rules for banks will need to stay in place until late this year, the central bank said on Wednesday.

The Reserve Bank of New Zealand (RBNZ) said house prices remain elevated and overvalued in some areas, but six-month-old restrictions on low deposit lending have had a positive effect of slowing house price inflation, credit growth and risk.

"The restriction of high-LVR (loan to value ratio) mortgages appears to be having the desired effect of moderating house price pressures and reducing the risk of a severe market correction," RBNZ Deputy Governor Grant Spencer said in the bank's six-monthly financial stability report.

However, he said it was too early to remove the limits, which are designed to help reduce the need to raise interest rates, because of concerns that strong immigration might give the sector a renewed boost.

"We consider that the earliest date for beginning to remove the LVR restrictions is likely to be late in the year," Spencer said, reiterating points made in a speech last week.

He said the LVR limits may be phased out rather than removed at once.

Real estate industry data earlier this week showed prices nudging up to record levels but the number of sales falling sharply.

Overall, the report said New Zealand's financial system was in its strongest position since the global financial crisis and that the risks to it had eased since the report last November.

Financial markets were largely unmoved by the report.

The report said New Zealand's banks were in strong financial shape, with adequate reserves and capital and low levels of bad loans. However, it highlighted risks from the high debt levels of a small portion of dairy farmers.

"A reduction in dairy export prices, and any associated fall in land prices, could place pressure on the more highly leveraged borrowers in the sector," said Governor Graeme Wheeler, reiterating comments made last week.

Dairy produce accounts for close to a third of New Zealand's NZ$50 billion annual export earnings.

The RBNZ said the improvement in the domestic savings rate and reduction in government debt needed to be sustained to constrain the country's high external debt levels, as seen in the current account deficits.

A sharp slowdown in the Chinese economy, the United States' move to tighten monetary policy, and any emerging market volatility were noted as significant external risks.

The RBNZ said it expected its rate-tightening policy, which started in March, to have more impact, more quickly because a large number of house loans would be up for renewal over the coming year.

However, Wheeler said the RBNZ was "feeling its way through" its interest rate policy, the impact it might have on housing, and what factors it would take into account when setting rates.

The RBNZ has lifted its cash rate by 50 basis points over its past two meetings to 3.0 percent, and it is expected to raise by another 25 basis points in June, after which it is seen as possibly pausing for several months because of a high exchange rate and restrained inflation pressures.

The RBNZ said it would also do a "stocktake" of its banking and finance company rules to look for improvements.

Analysts said Wednesday's report offered few fresh indications on the RBNZ's monetary tightening outlook, while early signs of higher house prices would keep the central bank vigilant on inflation pressures.

"The report reiterates that housing and dairy are the financial risks that New Zealand faces along with its high net external liabilities," UBS senior economist Robin Clements said.

"There's been talk that the Reserve Bank might be not far from a pause (in rate rises) ... but if house price momentum is turning up, then why would they pause? It doesn't seem to add up."

UBS expects the RBNZ will raise rates by 25 basis points at its next three meetings, in June, July and September, before then pausing. (Reporting by Gyles Beckford and Naomi Tajitsu; Editing by Leslie Adler)

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