The Reserve Bank (RBNZ) says the country’s houses are still overvalued and there’s a risk of prices falling below a level it deems sustainable.

The RBNZ made this comment in its latest biannual Financial Stability Report, as its efforts to cool inflation by lifting interest rates are seeing house prices come off astronomic levels reached in 2021.

The banking regulator said house prices are now “closer to being at sustainable levels than has been the case in recent years”.

“Current prices are within the range of fundamental values suggested by some of the metrics we monitor, but the overall balance across indicators suggests prices remain somewhat overvalued,” it said.

“In the near term prices may continue to soften, given the level of interest rates, the ongoing completion of houses currently under construction, and weak market activity and sentiment.

“However, there remains the risk of house prices declining significantly below our assessment of their sustainable level, particularly if the number of distressed sales picks up, generating self-reinforcing negative feedback effects.”

The RBNZ has never put numbers on what it deems a sustainable house price to be. One of its key roles is to maintain stability in the financial system, not target house prices, even though the latter can affect the former.

The RBNZ noted that nationwide, house prices are around 16 per cent below their peak, taking them back to levels seen around the start of 2021.

Prices in Auckland and Wellington are down 21 and 24 per cent from their respective peaks.

The RBNZ said negative equity is still at “relatively low” levels, meaning a small portion of borrowers owe the bank more than what their house is worth.

This is despite the around a quarter of banks’ current mortgage books originating from 2021 – when super-low interest rates enabled people to take out relatively large sums of debt to buy properties that have since fallen in value.

Of the lending done in 2021, around 20 per cent went to first-home buyers. The remaining 80 per cent went to other owner-occupiers, investors and businesses.

So, around 5 per cent of banks’ mortgage books can be attributed to borrowers who likely took out relatively large mortgages to buy their first homes at the peak of the market in 2021.

The RBNZ said most borrowers would still be able to continue to service their debt in a high interest rate environment without significant stress.

“However, this increased debt servicing burden is distributed highly unevenly, with some borrowers, such as those who fixed at the low of mortgage rates in mid-2021, seeing far greater rises in their debt servicing costs than others.”

It said that to date, there have been “limited signs of distress in banks’ lending portfolios.

“This reflects the ongoing strength of the labour market and that borrowers have been able to adjust their spending or use previous savings and repayment buffers. However, cash-flow pressures in households are growing and buffers are likely to be tested.

“A large rise in unemployment remains the biggest risk to domestic financial stability at present.”