Reserve Bank Governor Alan Bollard continues to warn of the risks of another property boom, pointing to the need to ensure the tax system does not advantage investment in property.

As the Reserve Bank published its six-monthly Financial Stability Report yesterday, Dr Bollard warned of the need to avoid a return to a "debt-fuelled housing cycle".

The report said a more cautious approach to credit expansion was warranted during the next economic upswing.

The Reserve Bank had a regulatory role to play, for example through the recently introduced prudential liquidity policy for banks.

The policy, which would come into force in April next year, would require banks to raise a certain proportion of their funds in the form of deposits or longer term wholesale borrowing, the report said.

Dr Bollard told reporters that for some years the Reserve Bank had pointed out the need to ensure property investment was not particularly advantaged in terms of its tax treatment.

"Because when it is, that draws extra funds into the housing sector, and the effect of that has been strong demand for mortgages, strong demand for external funding, pressure on the exchange rate, and pressure on the traded sector," Dr Bollard said.

"We don't think that's a good thing. We think it's quite important that people do understand that link between demand for mortgages, beyond what we're saving, and pressure on the exchange rate.

"We believe an appropriate tax change could help reduce that pressure."

The Reserve Bank had said it would stay vigilant about lending into a growing housing sector, but for now it noted credit was staying at low levels.

"We'd be prepared to use normal monetary policy tools, but also look at what is required to slow banking credit down," Dr Bollard said.

Liquidity policy had some potential as a longer term tool through the cycle to help ensure bank lending was moderated across the cycle.

The report said the Reserve Bank's new liquidity rules restricted the proportion of loans that could be funded through short term wholesale borrowing.

Since retail deposits in the banking sector were generally relatively stable, that would force future rapid rises in demand for loans to be funded mostly through long term, rather than short term, wholesale debt, raising funding costs and likely moderating credit growth.

"In the downturn, this pre-existing long term funding helps maintain investor confidence, and reduces the extent to which the bank will need to access (potentially troubled) wholesale funding markets, reducing any funding squeeze."

The report said there had been signs of an easing in lending standards for residential borrowers in recent months, with some banks prepared to offer housing loans at relatively high loan-to-value ratios.

"The housing market is currently strengthening, but we believe house price growth will slow after the current recovery phase," the report said.

"We would encourage the banks to avoid any return to riskier mortgage lending practices."

House prices still looked relatively high compared to history, and were still higher as a share of income than at any time before 2005, the report said.

Despite the pick up in housing market activity, household credit growth had continued at low and steady rates.

Slow credit growth may reflect some highly indebted sellers repaying mortgages, as well as households accelerating principal repayments now interest rates were low.

"Overall, the housing market recovery is likely to be limited, and subject to downside risks as interest rates start to rise from very low levels," the report said.

"Continued weakness in the labour market, along with falling agricultural incomes, could also weigh on the housing market."

Current low levels of interest rates made mortgages look relatively affordable compared to recent history, particularly if the loan was financed using a floating mortgage, the report said.

But floating mortgage rates would eventually rise as the economy started to recover, possibly placing stress on some first-time home owners who had entered the market at very low interest rates.

Longer term fixed mortgage rates, which were significantly higher, were likely to be a better guide to medium term mortgage affordability.