Towards the end of 1997, Irish borrowers on variable rate mortgages were paying about 7.5 per cent in interest charges to their bank or building society. The typical rate had fallen to roughly 5.1 per cent up to last month, worth £120 per month in interest savings to anyone who had borrowed £60,000.

Lucky borrowers. But there has been some negative reaction to the further round of interest rate reductions on mortgages, which look as if they will cut the typical rate to around 4 per cent.

The reason is that this latest cut was in response, or at least appeared to be in response, to the market entry of Bank of Scotland, which had spotted that margins in the mortgage business in Ireland were attractive, and announced a rate more than 1 per cent below the general level of rates in the market.

The argument is not about mortgage costs, which are at the lowest levels in memory, but about margins. Indeed the Consumers' Association released a report some months back which argued that margins in Ireland were excessive, at least in the mortgage business, and that they ought to fall.

Some banking industry sources during the week seemed to acknowledge that the Consumers' Association had a point, as they denied any credit to Bank of Scotland. Rates were coming down anyway, in their view.

There has been no collusive setting of interest rates in Ireland for over a decade, since the end of the cartel operated through the Irish Banks Standing Committee, with, it might be added, official approval. The market is competitive, but competitive markets often produce fluctuating margins. There will be bargains for consumers, but not all of the time.

The Central Bank publishes monthly data on interest rates, including the range of rates charged on variable mortgages. The cost of funds to the mortgage lenders is the one-month inter-bank (wholesale) rate, which governs what they can afford to pay for retail deposits. The gap between this rate and the average they charge for mortgages is a measure of the margin they enjoy. That margin has fluctuated widely.

Based on the Central Bank's figures, the picture is as shown in Table A:

Margins were about 1.2 per cent through the period January 1997 to September 1998. On a month-by-month basis, they fluctuated quite a lot, and the figure is of course an average across the market.

In October 1998, inter-bank rates fell from 6.08 per cent to 4.34 per cent, and have been falling ever since, to a current level of about 2.6 per cent. But mortgage lending rates have fallen much more slowly, as is clear from the chart.

What has happened is that the recent cuts have restored the lenders' margin to roughly its level of 1997 and the first three quarters of 1998. The 10 or 11 months in between have been good for the lenders.

It is very difficult to ascertain with any precision what might be a "correct" level of margin in any particular area of the banking business. In the early 1980s, Irish lenders were making provisions for bad debts which comfortably exceeded the margins we have seen in the mortgage market recently. Their margin must, in the absence of bad debts, cover all the normal running expenses, of course. The mortgage business will tend to generate few bad debt problems (or repossessions) in current Irish circumstances, and tight margins may be profitable. But an economic downturn would surely see margins rise.

THE widening of lenders' margins in the mortgage business through late 1998 and into 1999 is in need of explanation. Part may be due to sluggishness in cutting deposit rates in the early months. But it is also clear that some lenders had become concerned about the ability of borrowers to service the level of debt they were seeking to contract, and may also have begun to feel that house prices were approaching a peak. In these circumstances, with as many borrowers as you are comfortable with, why be the first to cut rates? Perhaps it became a slow bicycle race, and someone was bound to step on the pedals eventually. It turned out to be the Bank of Scotland.

Every silver lining has a black cloud. At 4 per cent, the demand for mortgages will accelerate, and fuel the demand for housing. In the absence of effective measures to increase supply, this is not a particularly welcome development. The Government should devote a little thought to the following question. If mortgage interest relief is a good idea when mortgages cost 7.5 per cent, does it remain an equally good idea when they cost 4 per cent?

Colm McCarthy is managing director of DKM economic consultants.