New Zealand's economy is likely to grow by 2.5% over the next few years but high house prices are a risk, the New Zealand Institute of Economic Research says.
By Susan Edmunds
It has released its June quarter predictions and says the economy is recovering gradually, boosted by the Canterbury rebuild and rapid growth in household borrowing.
But it said house prices were a risk, as was the prospect of households adding to already high levels of debt.
"Auckland house prices have risen sharply over the past year. When house prices stretch too far from incomes, they may fall if there is an economic shock."
It pointed to the United States and Britain, where inflation-adjusted house prices fell 30% in the recent downturn.
"Such an adjustment can have significant ramifications for the financial system, household wealth and economic activity."
The NZIER is still predicting OCR increases next year, although it says the Reserve Bank will also reach for its macroprudential tools.
"The RBNZ does not want raise interest rates too early because the recovery is still fragile and it is uneven across regions and sectors. Inflation is low and the exchange rate is high. Higher interest rates may lower inflation further and lift the exchange rate, which could stifle the recovery."
NZIER economist Shaumbeel Eaqub said the bank had to be careful, because outside Auckland and Canterbury, prices are still below their 2007 peaks.
"The OCR is a broad tool, everyone gets pnished at the same time. The Reserve Bank still wants to burture the economy but balance that against a hot, frothy market in Auckland."