Almost a decade and a half out from the financial crash, champagne cork-popping may still be unofficially verboten on the executive floors of Irish bailed-out banks.
But there would have been a few silent fist-pumps across the sector on Thursday as the European Central Bank (ECB) decided to hike its main rates by a further 0.75 of a percentage point — meaning that its main lending rate has moved from zero in July to 2 per cent.
“The ECB meeting yesterday was well received within AIB,” Donal Galvin, chief executive with the country’s largest mortgage lender, told analysts on a call on Friday, after the bank issued a rosy update.
As well it might. Ireland’s remaining banks are in a sweet spot right now.
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Having been dogged since the financial crisis by ultra-low interest rates internationally, shrinking loan books and demands from regulators to hold ever-increasing amounts of expensive capital, AIB, Bank of Ireland and Permanent TSB are rebuilding their loan portfolios again by carving up the carcasses of Ulster Bank and KBC Bank Ireland as the two overseas-owned lenders retreat.
[ Inflation accelerates to 9.5% in OctoberOpens in new window ]
[ AIB sees strong growth in income offset by higher running costsOpens in new window ]
With the ECB raising rates for the first time in more than a decade in an effort to fight inflation, the income yield on their expanding loan books is also moving higher.
AIB estimates that every one-percentage-point increase in euro zone rates would boost its net interest income by €300 million — assuming its own pricing moves in line with official rates. The main income boost so far has been on AIB’s deposit book, rather than its loan book.
The bank had about €39 billion of excess cash parked with the ECB at the end of September, as it only has €61 out on loan to borrowers for every €100 of customer savings it holds. Until July, it was being charged a negative rate of minus 0.5 per cent by Frankfurt. After Friday’s move, the deposit rate stands at 1.5 per cent — at a time when AIB’s own deposit holders are earning little or nothing on their cash.
Although AIB is alone among the mainstream banks in hiking mortgage rates since the ECB first move in July, it has, so far, only added 0.5 of a point to the cost of new fixed-rate mortgages.
Banks are among the few winners in a rising rates environment. AIB’s share price has risen almost 35 per cent so far this year, while Bank of Ireland had added 42 per cent — mainly as they played catch-up to the type of valuations seen across the wider European banking sector.
Irish banks are much more reliant on interest income for earnings (equating to 80 per cent of operating profit in 2020, according to Banking & Payments Federation Ireland figures) than your average bank on the Continent, which have higher levels of fees and commissions.
AIB executives say they have not yet seen the cost-of-living crisis — with domestic inflation running at an EU-harmonised rate of 9.5 per cent — affecting customers’ ability to meet mortgage repayments. Still, winter energy bills have yet to land. And lenders are only getting started on rate increases.
Banks face a tricky balancing act. If they are too gung-ho at raising interest rates at a time of heightened economic uncertainty, they may end up taking a hit further down their income statement by way of provisions for likely bad-loan losses.
Having presided in recent months over the sharpest rise in ECB rates since the introduction of the euro, the bank’s president, Christine Lagarde, struck a slightly more dovish tone on Thursday, stressing that the potential impact of a recession on inflation will be a key consideration for future decisions.
“[This] suggests a less-aggressive rate hike path ahead,” said strategists at Amundi, Europe’s largest asset manager.
It may be a temporary respite.
The ECB’s central task is price stability, which it sees as inflation over the medium term of about 2 per cent — a fraction of the 9.9 per cent at which euro zone consumer prices were rising in September. Inflation has been broadening out across various goods and become more persistent in recent months.
In an effort to see where we’re headed, Deutsche Bank analysts have gone back to the 1920s to study 318 separate occasions globally when inflation topped 8 per cent.
“Throughout the global inflationary spike of the last 18 months, a persistent theme has been how economists across the board have underestimated both its magnitude and direction,” said the Deutsche analysts. “But in reality, should we have been so surprised by the stickiness of inflation? History would suggest no.”
ECB staff economists, who were predicting a year ago that a spike in inflation at the time was “transient” and a result of supply bottlenecks following the worst of the pandemic, forecast last month that euro zone price growth will fall back to about 2.3 per cent in 2024.
However, the Deutsche number crunchers found that inflation, on average, took around two years after passing the 8 per cent threshold to even fall beneath 6 per cent, before settling around that level for up to five years after the shock.
“Whether the historical evidence or consensus expectations prove to be more accurate will have a profound impact on financial markets and economies over the next few years,” they concluded. “If the median through history is correct, then the turbulence of 2022 could prove to be just the beginning.”
The financial pain that will befall households and businesses during a drawn-out period of inflation — or from the type of action the ECB may need to take to avoid it — would inevitably hit bank earnings.
