What happened at Thursday’s meeting of the ECB’s governing council?
The European Central Bank increased interest rates for the first time in almost exactly 11 years. Since it cut interest rates after the financial crash there has been an unbroken period of super-low borrowing costs. Now the ECB has pushed up its interest rates by half a percentage point. And there is more to come, with another increase in early September almost certain and more before the end of the year. The ECB is well behind other central banks which have already increased their rates: UK base rates are at 1.25 per cent and US rates at 1.75 per cent, and both are due to rise again shortly. This leaves Europe in catch-up mode on interest rates and borrowers in danger of feeling more pain through the autumn and winter.
What’s the point of increasing interest rates at all?
Higher interest rates are the traditional tool used by central banks to control inflation, as they slow economic growth and the demand for money. But this time, inflation is rising mainly because of higher energy prices and other supply-side problems. Higher borrowing costs won’t stop this happening, but the idea is that they would make it less likely that inflation would spread and get embedded. And managing people’s expectations of future inflation is seen as vital. But if economic growth slows while inflation stays high, then the ECB and other central banks will be in the firing line. And this could happen over the winter if energy prices rise further.
How will the ECB decide what to do next?
It will watch the inflation figures and keep its fingers crossed. The ECB has no more idea than the rest of us how the autumn will play out; it says it believes Europe will probably avoid a recession, but if Russia cuts off gas supplies completely then a recession is what will occur. It indicated that it wants to see interest rates move back to “normal” levels, though no one is quite sure what this is. And if Europe gets into economic trouble, it may have to put its rate hikes on hold. Central banking is often more art than science, despite all the important-sounding jargon that surrounds it.
What is the outlook for Irish borrowers?
Tracker mortgages (which “track” the ECB base rate) will go straight up in response to the latest hike and will probably rise further in the months ahead as the ECB hikes further. Banks have more flexibility with ordinary variable rates; they haven’t increased yet but will at some stage, and like trackers will go up further as official rates rise. New fixed-rate offers for homebuyers will also rise. Some of them have edged up already, but there is still what looks like value in the market here. Those on older variable rates would be well advised to consider their options, as many of the fixed rates on offer are below the current variable rate they are paying. Ireland has a lot more fixed-rate mortgage debt than 10 years ago, and this will offer some protection to newer borrowers, but as fixed-rate periods end, borrowers will move on to higher rates.
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Anything else to watch?
Oh yes. The ECB has told the market about a new mechanism it will use to try to stop market speculation against slower growing and highly indebted member states by buying their debt. Italy is seen as first in the potential firing line, and its cost of borrowing has already risen in recent weeks. The fall of Mario Draghi’s government increases the risk. There is conditionality in ECB support for countries in trouble. They need to follow what are judged to be sustainable budget policies. This could be controversial in Italy, now heading for a general election. There is potential for trouble here.
