Big rate rises to fight inflation could plunge property market by 20-25pc: banker Joseph Healy

Warning aggressive RBA rate hikes to bring down inflation could have dramatic consequences for the property market.

Joseph Healy, co-founder of Judo Capital, says there’s an unprecedented array of forces bearing down on the local and global economy. Picture: Britta Campion / The Australian

House prices could crash by 20-25 per cent if the Reserve Bank dispenses its traditional medicine of big interest-rate hikes to bring surging inflation under control, according to one of the nation’s most experienced bankers.

Joseph Healy, co-founder of SME lender Judo and a former head of NAB’s business bank, said there was an unprecedented array of forces bearing down on the local and global economy – rising inflation, higher interest rates, a relatively weak Covid-affected economy, supply chain disruption and labour shortages.

“People are perplexed and they’re looking for the play book but the truth is there isn’t one because this is a truly unique set of circumstances,” Mr Healy told The Weekend Australian.

“There will be pressure to lift interest rates to control inflation but pressure, as well, to avoid killing the economy stone dead, so the Reserve Bank’s response is the single biggest policy question, just as it is for the UK and US central banks.

“If the RBA tries to kill inflation through rate increases, there will be huge economic damage and it’s really hard not to see a material correction in property prices of 20-25 per cent.”

Mr Healy said that central banks in the past had lifted official rates to 1-2 percentage points above the inflation rate to squeeze inflation out of the system.

With inflation running at about five per cent, that would imply a cash rate of 6-7 per cent – much higher than RBA governor Philip Lowe’s commentary last month that it “wasn’t unreasonable” to expect the cash rate to return to 2.5 per cent.

The question, therefore, was: what does the RBA do to return inflation to its targeted range of 2-3 per cent?

Mr Healy’s assessment was that the central bank would effectively lose its independence from the political process and that the health of the economy would be prioritised, even if it came at the expense of persistently high inflation.

“The question then becomes: what are the economic consequences of high inflation over a long period?” he said.

The Judo founder was speaking from London on the final leg of a Judo investor roadshow through Singapore and Abu Dhabi.

Despite Judo’s status as a single-purpose SME lender, he said the most persistent question he had faced on the roadshow was the systemic risk posed by Australia’s “eye-watering”, $1.9 trillion of mortgage debt in the regulated banking system.

“There’s been substantial house-price growth, household debt has increased and there are geopolitical issues which could trigger a significant downturn.”

The risk, which has long been a concern for offshore investors, was even greater once non-bank debt was included, and now that rates were lifting from their near-zero level.

Credit rating agency Standard & Poor’s was more sanguine about the outlook, saying it did not expect rising credit losses from the banking industry in the next two years.

Analyst Sharad Jain said S&P believed house prices would only fall by five per cent in the coming 12-18 months, although the risk of “something going wrong” was now elevated.

“There’s been substantial house-price growth, household debt has increased and there are geopolitical issues which could trigger a significant downturn,” Mr Jain said.

“So we agree that there’s a higher risk but it’s not our base case.”

APRA chairman Wayne Byres, who has persistently warned about risks associated with the heavy skew towards mortgages in bank balance sheets, highlighted on Tuesday that loan losses from corporate and commercial property customers used to outweigh mortgage losses in the regulator’s stress tests.

But now, with mortgages growing to more than 60 per cent of the industry’s total loan portfolio, the situation had reversed.

“Housing loans have been, as they say, safe as houses,” the Australian Prudential Regulation Authority chief said.

“That may not be the pattern in the future.”

This reflected not only the growing proportion of housing loans in the total book, but also the larger share of more heavily indebted borrowers.

In April, the RBA said in its Financial Stability Review that the share of new mortgage lending with high debt-to-income levels of greater than six had increased significantly to 24 per cent in the December quarter of 2021.

The ratio remained at a higher level in early 2022.

There was also “notable” growth in the share of new lending at high loan-to-valuation ratios of more than 90 per cent over 2020, although this had since declined.

On Friday, ahead of next week’s RBA board meeting, Commonwealth Bank and ANZ Bank hiked the full spectrum of their fixed-rate loans, following Westpac’s lead late last month and NAB last Friday.

Westpac chief economist Bill Evans pulled out his crystal ball, predicting a jumbo-sized rate increase by the RBA of 40 basis points, taking the cash rate to 0.75 per cent.

This would unwind the emergency rate cuts implemented in 2020 to soften the hit from the global pandemic.

If high household debt and rising rates are the risk factors, then JPMorgan Chase chief executive Jamie Dimon pointed to the fuse overnight on Wednesday, saying that the “storm clouds” he had identified only last week were actually a “hurricane”.

“That hurricane is right out there down the road coming our way – we just don’t know if it’s a minor one or Superstorm Sandy … and you better brace yourself,” Dimon said.

While the ignition point remains uncertain, Mr Healy said Australia was effectively a “mortgage economy”.

Any major correction, he said, created elevated risks for the wider economy, as discretionary spending was wound back.

“So this train has been coming for a long time,” the Judo boss said.

“Wayne Byres is quite right to flag his concerns, but you can take stress tests with a pinch of salt.

“The banks always say they’re not concerned and they cite a lot of data about their average borrower, but it’s not the average borrower that’s the concern; it’s the marginal borrower.

“There is an unhealthy trend in the system and one day it’s going to be a problem.”