In real terms - ie stripping out the effect of inflation - interest rates still remain close to zero, writes Marc Coleman, Economics Editor.
The European Central Bank has put a slight dampener on this week's Budget party. In a move signalled well in advance, the ECB's governing council yesterday upped the main refinancing rate - the bank's key lending rate - by a quarter of 1 per cent.
The result, according to IIB Bank chief economist Austin Hughes, is that someone with a €250,000 mortgage over 25 years will be €35 a month worse off as a result of yesterday's rise, the sixth quarter-point increase to take effect since last year's budget. That €250,000 mortgage holder will be €210 a month - or about €2,500 a year - worse off than in December 2005 when the final rate is passed on by the mortgage lenders.
Several factors are putting most mortgage holders beyond the reach of the ECB's tightening grip. For a start, average incomes have increased by about 6 per cent, an annual increase in net terms of about €1,200 for the average industrial earner.
Inflation has increased from 2.5 per cent to 4 per cent since - and partly because - the ECB started raising rates. This has a profound dampening effect on interest rate rises.
To understand why, consider why the ECB raises rates in the first place. Higher interest rates are supposed to act as a disincentive against borrowing and as an incentive to investment over consumption. Inflation does precisely the reverse, by lowering the future purchasing power of money.
In extreme cases - Germany after the first World War for example, where inflation was several hundred per cent a year - workers spent their pay packets within hours of receiving them, knowing that their value was declining by the day.
Despite yesterday's interest rate rise, Ireland's current inflation rate of 4 per cent remains about half a percentage point higher than the ECB's base rate. Compared to the rates being applied by most mortgage lenders, inflation is just about the same.As a result, in real terms - ie stripping out the effect of inflation - interest rates still remain close to zero.
Now consider the Budget. First-time buyers who have bought their property within the last seven years will gain about €800 a year from the doubling of mortgage interest relief.
For these more vulnerable buyers, the Minister for Finance has more than reversed the impact of the ECB's latest rate tightening on the notional average buyer referred to above.
Between them, the impact of higher earnings growth, inflation and - for new and recent first-time buyers - increases in mortgage interest relief, combine to nullify the entire impact of ECB rate increases, yesterday's included.
The coup de grace comes from changes in personal income tax. Changes announced in the Budget mean that income earners have gained between 1 and 7 per cent in net terms for a range of increases in tax credits and thresholds, as well as a cut in the top rate of tax.
According to Eunan King of NCB stockbrokers, another rate increase is definitely in prospect before the next election and a second one is not out of the question. However unlikely those increases are to offset what Mr Cowen has done, voters tend to remember the economic events when casting their votes on election day - as the Government's tendency to save major tax cuts and social welfare increases until the final year before the election testifies.
Small economic events that occur close to an election can have a greater impact than far larger events that have gone before. What a rich irony it would be if Wednesday's Budget was erased from voters' minds by future ECB rate increases.
