For a while it seemed that have to fall soon, if only due to the sheer weight of optimism which abounded. But even the most ardent EMU advocates are now realising that it is very likely that the Central Bank is not going to reduce interest rates until as late as possible during the final quarter of the year. This prognosis is not based on the contrarian principles much favoured by some commentators. The Central Bank, our regulator for the short time left to it, has stated again and again - most recently last week - that it wants to see rates stay at current levels for as long as possible, which we must presume to mean to as close as possible to the end of the year. Recent credit figures showing annual growth of 22 per cent must also be giving the Central Bank cause for concern.
The predictions that mortgage rates will fall to 5.5 per cent or lower, seem overly optimistic. Yes, interest rates are due to fall. Yes, banks and building societies can, and may, pass on some of the reductions to borrowers. And yes, competitive foreign banks may enter the Irish market and force rates down. The fall-out from the Russian situation is now also giving a further reason for low interest rates.
However, it should not be forgotten that the main concern for the new European Central Bank will be to engineer the smoothest possible transition to the euro, especially in the period immediately following the changeover. It has issued numerous warnings about inflation, pointing in particular to the smaller member states, with an emphasis on Ireland. Only a few months ago, Ireland qualified at the top of the league for entry to EMU. In recent times, , that ranking has been severely dented as economists continue to point out how we now have the "worst" - i.e. highest - rate of inflation of all the EMU member states.
Inflation cannot be ignored and, for this reason, we should expect interest rates in the euro zone to start at a level closer to 3.75 per cent to 4 per cent, rather than the original expectations of 3 to 3.5 per cent. As a consequence, Irish mortgage holders may not see the sizeable reductions they have been told to expect. Right now, two and three year interest rates on the wholesale money market are about 4 per cent. After that, the yield curve begins to rise again which means, four years out, the market expects rates higher than 4 per cent. Why? For no better reason than it has always been impossible to accurately predict interest rates beyond one or two years. So, expect higher, rather than lower, rates. Feeding into this expectation is the reality that the whole concept of EMU is unprecedented. No one really knows how it will all work out. Uncertainty creates nervousness, and nervousness can send interest rates to dizzying heights, especially when inflation worries are added to the equation.
The hope is that monetary union will lead to a sustained low interest rate environment throughout the euro zone. But how long can this be sustained? Irish inflation is rising and may continue to do so, as may inflation in a number of other euro states. Lower interest rates, the main selling point for the whole euro project, will accelerate this process. Add to this scenario the other European countries who are eager to join the euro club and who may bring their own particular economic problems along with them. The more participants there are, the less stable the euro zone may become. Moreover, the ECB needs to be seen as firm, committed and powerful in the execution of its duty which is essentially to police EMU and all its participants. It is crucial that EMU proves to be credible and viable on a long-term basis, so Mr Wim Duisenberg and his colleagues do not have an easy task ahead.
With regard to 10 or 20 year fixed mortgages, I would strongly recommend that borrowers give this option a good deal of thought, especially since the average life of a mortgage is about seven years. Long-term rates may provide certainty in terms of monthly repayments, but may come at an additional cost. As things stand, banks and building societies are known to be quite merciless when it comes to breaking a fixed term mortgage, even if it is only fixed for 3 or 5 years.
Building societies have admitted in recent weeks that while variable mortgage rates will come down, the fall in fixed rates will not be anywhere as substantial. Ten or 20 year fixed mortgages are very unlikely to come gift wrapped - that is without penalty clauses. Anyone tempted to go this route would want to be very sure of their financial circumstances for the full term of the loan, or they may find themselves expensively stuck.
If it is not already the case, prudence should be the name of the game in the short term. If we do return to a positive yield curve - with longer term interest rates higher than shirt-term ones - will we "really" see lower mortgage rates on offer next year or the year after, or the year after that? The bottom line is, do not be too tempted by promises of mortgages at giveaway prices. If your mortgage is due for renewal now, the dilemma is whether to fix at the best 3 year rate available to get comfortably over that first year of EMU so that all its teething problems will, hopefully, have been soothed and smoothed away by 2001.
The alternative option is to fix for one year. By then we will know for sure if rates really will be at a realistically all time low. At that point, fix longer term and sit back, with fingers crossed, to watch the consequences of EMU truly unfold.
Ms Burke is Treasury Manager at Equity Bank.
