On December 14th, ECB president Christine Lagarde said after the European Central Bank’s governing council meeting that the bank should “absolutely not” lower its guard against inflation and had not even discussed the issue of when interest rates should fall. But a statement earlier in that week from US Federal Reserve Board chairman Jay Powell that the Fed was “very focused” on not waiting too long to cut interest rates — and the general tone of its forecasts — had already sent interest rate markets into action. By the time ECB chief economist Philip Lane repeated the Lagarde mantra in Dublin in the week before Christmas, longer-term market interest rates had dropped further. If this trend holds, it will change a lot of things going into 2024.
The scale of what happened in the final weeks of this year is striking. From mid-October to late December roughly one percentage point was knocked off longer-term Irish interest rates on financial markets — measured by the cost of borrowing to the State and products used by banks as key markers for many of the interest rates they charge to the public. For example, a five-year interest rate which would be one guide to the price mortgage borrowers get charged for fixed-rate loans fell from 3.5 per cent in mid-October to below 2.5 per cent by late December. In the land of interest rates, that is super fast.
If this holds, we might expect to see competition starting to lead to lower three- and five-year fixed-rate offers to borrowers early enough in 2024, helping first-time buyers but also the many thousands coming off existing fixed-rate loans and looking at their options. Tracker interest rates will only fall when the ECB cuts its official rates, but the cost of fixed interest rates depends on what is happening in the market.
The rise in inflation was caused by an unprecedented mix of factors — and so what happens next year is impossible to forecast with any confidence
Some health warnings are needed here. One market observer I spoke to said the behaviour of investors in recent months was like people running from one side of a boat to the other. Volatility is often seen at turning points in markets, with market analysts wondering, in this case, how quickly interest rates might now fall.
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And it is quite possible that the ECB is right, that inflation will stall at a higher level than anticipated, and that its interest rates will not be able to fall until, perhaps, the summer. The rise in inflation was caused by an unprecedented mix of factors — and so what happens next year is impossible to forecast with any confidence. The ECB points to wage trends as a worry. But for now, the markets are betting in the opposite direction, reckoning that weak growth and falling inflation will be the stories of 2024.
Remember, for interest rates, bad news is good news and weaker growth sends borrowing costs lower. Ireland has benefited, in the past — for example during the Celtic Tiger years — from weakish EU growth as this led to relatively low-interest rates. When this was mixed with stronger US growth, it was a powerful cocktail for the Irish economy.
Of course, this blessing of strong growth and low-interest rates was eventually turned into a curse, as low borrowing costs encouraged an unsustainable bubble in property-based lending. You really can get too much of a good thing.
The old one about ‘never betting against the house’ suggests that it is a mistake to speculate against the central banks
Whether the ECB’s caution or the bond market’s bullishness proves correct will be one of the vital things to watch as 2024 starts to play out. You can choose your cliche here. The old one about “never betting against the house” suggests that it is a mistake to speculate against the central banks. But then there is the saying from Bill Clinton’s famous adviser, James Carville — the man who coined “It’s the economy, stupid” — who famously said in the wake of a 2004 market collapse that if he was reincarnated he wanted to come back as the bond market, as it can intimidate everybody.
As this plays out, the ECB will worry that the lower interest rates on the financial markets will in themselves loosen borrowing conditions enough to damage its efforts to get inflation down. Could this even delay the ECB’s decision to cut its own official interest rates? Or could it force its hand to move? Either way, the bond markets versus the bank is a heavyweight contest to watch next year and one with big implications.
2023: The year in business
If the downward trend in interest rates does take hold, then it improves the growth outlook Irish economy, which slowed markedly towards the end of this year. It would not remove the financial shock that the 70,000 or so coming off fixed-rate mortgages in 2024 will face, but it would reduce it. Those on trackers would benefit as ECB rates fall. Business would gradually see lower borrowing costs benefiting them, a particular help to many of the smaller, squeezed firms in sectors like hospitality and retail. And a decline in borrowing rates helps the housing market — by benefiting demand, lowering funding costs and, importantly, lowering the bar for those looking to invest in the housing market because they now get a lesser return from putting their money into low-risk assets like Government bonds.
Importantly, falling Government bond market rates also make it cheaper for the State to refinance old State borrowings, helping the outlook for the public finances.
Finding a new equilibrium will not be easy. And there are likely to be bumps on this road in early 2024
The rise in the price of money over the past 18 months has upended a lot of things. And we all know that there is no going back to the rock bottom rates which persisted in the period from after the financial crash right through Covid-19. This led to a flood of cash looking for a home across the world economy, pushing up stock and bond markets and causing investors to look at putting money into areas like housing in Ireland. There was no return in bank deposits or other safe havens, so getting a return required taking a risk.
Finding a new equilibrium will not be easy. And there are likely to be bumps on this road in early 2024. But in the final weeks of 2023, something important has happened. The financial markets have bet — and bet heavily — against the mantra from the central banks that interest rates will have to stay “higher for longer” to get inflation down. A lot hangs on whether they are right.