We have moved into the “phoney” war phase on interest rates. Everyone knows they are going to fall at some stage next year, but the European Central Bank (ECB) has been saying that it is too early to talk about it and that the battle against inflation is not yet quite won. This message was repeated after Thursday’s meeting of its governing council, with a pledge to keep interest rates high for “ as long as necessary”.
This is a tactical manoeuvre to keep its options open and also an attempt to stop financial markets “getting ahead of themselves” and reducing market interest rates too quickly – which could damage the fight against inflation. But recent euro zone inflation figures mean another rise in interest rates is off the table and attention is now turning to when they will fall. This was underlined by the ECB’s own cuts to its inflation forecast for the next few years, published after yesterday’s meeting.
Amid all this noise, how do mortgage holders make sense of what is going on? Here are the implications for the three main types of mortgage in the State.
1. What if you stuck with your tracker?
Some people switched from tracker mortgages to fixed rates as interest rates went up over the past 18 months. However many stayed where they were. Mortgage broker Michael Dowling of Dowling Financial says many tracker holders felt they had benefited significantly for many years, reckoned rates would fall again in time and wanted to keep the flexibility of paying off a lump sum without penalties, which is not generally available on fixed rate products.
The cost of this decision was a succession of interest rate increases for tracker rates tied to the ECB refinancing rate, which – along with its key deposit rate – has risen by 4.5 percentage points since summer 2022, a record pace of increase.
Tracker mortgages pretty much all date back to before 2008, so borrowers are well into their loans, with average balances, according to Dowling, of €135,000. This means that, for many, the increases were manageable, if painful. However, Central Bank research has shown that a smaller group with larger outstanding balances suffered particularly from the increases and made up the biggest group of borrowers worst affected by rate rises.
While tracker holders took the pain up front, they will also reap the benefits of lower interest rates quickly. So when might rates start to fall? On the face of it, soon enough, given that euro zone inflation fell in November to 2.4 per cent, close to the 2 per cent ECB target.
However, this headline rate is likely to bounce around in the months ahead, partly because of the impact on the data of household energy supports across the euro zone, which are now reducing in value. Also, core inflation, excluding the volatile elements of energy and food, while falling faster than the ECB had estimated, is still at 3.6 per cent. And the ECB is concerned about wage trends - as Lagarde again made clear yesterday - and their impact on the price of services in particular.
Are cheaper energy prices finally on the way for Irish consumers?
Nonetheless, euro zone growth is weak and barring another upward spike in energy prices, financial analysts are arguing about whether the first interest cut might be in the spring or the summer.
Market expectations have changed substantially over the past couple of months, according to economist Simon Barry, as inflation has fallen. Market prices now imply that the first interest rate cut could come as early as March or April.
After that, a downward trend is expected, though this will not return interest rates to the rock bottom levels seen up to the middle of 2022. According to Barry, markets are now pricing in a 1.25 -1.5 percentage point cut in ECB rates next year and a further,smaller decline in early 2025.
The low point at which interest rates might bottom out over the next 18 months to two years is hard to judge. But it is hard to see tracker rates in Ireland falling much below 3.5 per cent, barring a big economic downturn. Even if the ECB’s main deposit rate falls to 2 per cent from 4 per cent now, the ECB’s refinancing rate would be 2.5 per cent – and most trackers have a margin of a bit over one percentage point.
Some analysts believe that the decline, when it starts, will be rapid.On Friday, Barclays Bank said that they believed ECB interest rates would start to fall next April and would be cut by a quarter point at each successive meeting to bring the deposit rate to 2..25 per cent by January 2025- a cumulative decline of 1.75 percentage points. That would mean the refinancing rate off which trackers are priced would fall to 2.75 per cent, bringing most tracker rates down to the 3.8 to 4 per cent range.
However, the debate will take time to play out and reports suggest that more cautious members of the ECB council do not believe interest rate cuts should start until the middle of next year. Some analysts are also cautious, arguing that the market view on the pace of interest rate reductions is too optimistic - and experience shows that market pricing can be a poor guide to official interest rate moves. If these voices are right, the first rate cut could come a bit later and the cumulative declines over 2024 could be a bit less. However, as Barry points out, the ECB could cut rates quite a bit from current levels and they would still be at what is judged to be a restrictive level, slowing growth overall. The neutral level of official rates is a matter for debate, but is probably around 2 to 2.5 per cent. So, 2024 looks a lot better for tracker holders than 2022 and 2023.
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2. Are you rolling off a fixed rate?
More than 60,000 people were due to roll off a fixed rate this year and a further 70,000 or so next year, according to Central Bank research – with similar numbers in 2025 and 2026. Most will have locked in at three- to five-year rates of between 2.5 per cent and 2.75 per cent and would now be coming back on to a market where most fixed rates are in the 4.25 per cent to 4.75 per cent range.
According to Dowling, the average fixed rate product has risen by about 2.25 percentage points over the past 18 months. The main banks do now offer lower “green” rates for houses with high BER ratings – many below 4 per cent – and there can also be value among the smaller lenders, with Avant marketing rates of under 4 per cent.
So those rolling off fixed rate products face a significant hike in repayments and as most will be newer borrowers, many will have relatively high outstanding mortgage balances. Monthly increases could run to a hefty €250 to €300 for many as things stand.
These products are generally priced off longer-term market interest rates (so-called swap rates). Banks did not increase fixed rates to fully reflect market moves. But as the market rates are coming down, there are hopes that fixed rate offers will improve a bit through 2024 as well and probably into 2025.
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The days of being able to fix around 2.5 per cent are gone – those moving into new loans will face significant enough increases whatever happens. So even as ECB rate declines boost those on trackers, those coming off fixed rates will still face higher repayments. However both Barry and Dowling feel lower market rates could give the banks the option to reduce fixed rates a bit during 2024, reducing the pain a bit.
Those with sizeable loans might find it worthwhile to take professional advice on how best to approach this, given the complicated options on different loan-to-value ratios and BER ratings.
The possibility of fixed rate offers falling as the year goes on also needs to be considered.For some there might be a case to move to a variable rate for a period, if it does look like fixed rates are on the way down, allowing a lock-in at lower rates later in the year.
But with large variations in the variable rates on offer and competition likely to boost fixed rate offers as banks strive to hold on to customers, care is needed to assess all the options. Moving to another lender always remains an option, but that does involve costs and hassle. For those considering a move, key advice from experts is to focus on the interest rate on offer and not on any once-off cash incentives to switchers.
3. Are you still on an old variable rate?
Many people moved off relatively expensive standard variable interest rates as the costs increased from summer 2022 on. The average outstanding balance on variable loans is under €100,000.
Generally banks have been slow to push up variable rates in response to ECB rises – many were already at relatively high levels. So the scope for reductions here is less, particularly as banks are under pressure to increase the rate paid to savers. PTSB recently hiked its variable rate.
Many borrowers whose loans were transferred to nonbank lenders are also on variable interest rates – and some have been paying the highest rates on the market at 8 per cent plus. Given that these nonbank lenders hiked rates generally in tandem with the ECB, they should do likewise on the way down.
If they don’t, they need to come under pressure from the Government and the Central Bank who assured people whose loans were sold that they need not worry; in reality, some have suffered as interest rates soared.
