When do the side effects of a medicine outweigh the benefits? When it comes to higher interest rates to address rising inflation, central bankers would probably say, never.
Former US Federal Reserve chairman Paul Volcker raised interest rates to a recession-inducing 22 per cent in the early 1980s to break the back of inflation. His actions brought the US economy to its knees and put the US housing market into a semi-slumber. Anybody who was paying a mortgage in the Republic in the 1980s will need little reminding of that period.
At the publication of the Central Bank’s latest Financial Stability Review on Thursday, governor Gabriel Makhlouf said that while a certain cohort of mortgage holders were hurting under the weight of 10 interest rate hikes from the European Central Bank (ECB), inflation affects the entire population.
The side effects of higher interest rates have already caused a slowdown in demand globally and a contraction in the Irish economy in gross domestic product terms. The worst of it, however, may still be ahead of us.
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The Central Bank’s review and Makhlouf himself cited the “lagged effect of monetary policy” as the chief source of uncertainty for the domestic economy.
Approximately half of mortgage holders here haven’t felt the impact of higher interest rates yet because they are on fixed-rate contracts agreed prior to the current interest rate cycle. However, up to 19 per cent of 730,000 mortgage holders here, equating to almost 140,000 borrowers, are due to roll off these fixed contracts in the next 24 months. How they will react, or how they will be prepared financially is an unknown space.
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Companies in the commercial real estate sector, which tend to have shorter loan durations and therefore quicker financing rollovers, are already feeling the brunt of this cold interest rate wind. Commercial real estate prices have now fallen more than 20 per cent since mid-2020, Makhlouf noted.
Either way, the economic outlook here is clouded by the uncertain impact of ECB rate hikes.
The benign outlook is for anaemic growth for several quarters or even a technical recession, defined as back-to-back quarters of negative growth, followed by a pick-up in demand on foot of less inflation and a gradual lowering of interest rates.
The Irish and the euro zone economies contracted in the third quarter and a further softening in the fourth quarter will mean we’ll be in a recession by Christmas.
The less benign outlook is for a more sticky level of inflation, necessitating interest rates being kept higher for longer, and ultimately a more stagnant economic environment, one that won’t feel “technical”.
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