Soaring house prices in Tauranga and Hamilton have put the Reserve Bank on edge, with the two cities being singled out in their latest financial report.

According to One News, the Reserve Bank says house prices in Tauranga and Hamilton are rising at 18 and 14 per cent respectively each year.

The Reserve Bank is closely monitoring recent rises in house price inflation in areas such as Hamilton and Tauranga. Photo: File.

They claim while this could be positive if it reflects a spreading demand from the overheated Auckland market, the Bank says a prolonged period of sustained price hikes in both cities could be bad for financial stability.

The Reserve Bank has vowed to closely monitor both areas.

Reserve Bank Governor, Graeme Wheeler, says New Zealand's financial system continues to perform well despite a deterioration in the outlook for global financial stability and increased risks related to the dairy and housing sectors.

'Global economic growth has softened over the past six months, and uncertainty over the path of economic and financial adjustment in China has helped to depress commodity prices and added to financial market uncertainty,” says Graeme.

'Interest rates at historic lows are encouraging higher leverage, leading to a build-up in risk in international asset markets.

'This environment creates risks for the New Zealand banking system, which remains reliant on the global markets for funding.

'The dairy sector faces a second consecutive season of weak cash flow due to low international dairy commodity prices.

'Prices have shown some recovery since August, but many indebted farms are coming under increased pressure, which would be exacerbated if low dairy prices are sustained or dairy farm prices fall significantly.”

House price growth in Auckland has increased strongly, with house price-to-income ratios in the region now comparable to those seen in some of the world's most expensive cities.

Rising investor activity has been an important driver of price developments, and international evidence suggests that investor loans have a higher tendency to default in the event of a major downturn in the housing market.

'A sharp downturn could challenge financial stability, given the large exposure of the banking system to the Auckland housing market,” says Graeme.

'While it is still too early to judge the effect of recent policy changes, they are expected to help moderate pressure on Auckland house prices, and will improve the resilience of bank balance sheets to a housing downturn.”

Deputy Governor, Grant Spencer, says that 'banks hold strong capital and liquidity buffers and have maintained their profitability with further reductions in cost-to-income ratios.

Lending growth to households and businesses has picked up and is being funded mainly through higher domestic deposits.

'New rules on Auckland residential investor loans came in to force on November 1. The bulk of these loans are now required to have a loan-to-value ratio (LVR) of no more than 70 per cent.

'LVR restrictions have been eased outside of Auckland where housing market activity has been more subdued. However, the Bank is closely monitoring the recent rises in house price inflation in some areas such as Hamilton and Tauranga.”