In the immediate aftermath of the Russian invasion of Ukraine, financial markets speculated that the resulting threat to economic growth could delay moves by central banks to increase interest rates. In the intervening weeks, however, opinions have changed. The US Federal Reserve Board has just increased its key rate by 0.25 of a point – and signalled six similar rises to come this year. Meanwhile the European Central Bank has said that it plans to withdraw support for government borrowing markets this year, a precursor to what would be the first interest rate increase in a decade.
It is likely to be next year before the ECB increases its main interest rates, triggering an increase in the cost of tracker mortgages
Central banks are being driven by exceptionally rapid increases in the rate of inflation and by the fear that this will fundamentally alter future perceptions. If an inflationary psychology sets in, it can be very difficult to dislodge. Central banks fear that delaying too long could require steeper interest rate increases at a later date.
With huge uncertainties caused by the war in Ukraine, these are difficult judgments. But for now consumers and businesses would be well advised to plan for some increases in borrowing costs. There are already some moves in the mortgage market, though it will be later this year before the outlook is clear. By then, on current expectations, fixed rate offers for new borrowers might be on the way up and possibly variable borrowing rates too. It is likely to be next year before the ECB increases its main interest rates, triggering an increase in the cost of tracker mortgages.
Borrowers will hope that interest rate increases are limited. For this to happen, a moderation of inflation later this year will be required. This is quite possible but far from guaranteed.
This trend is also vital for State borrowing. During Covid-19 the Government benefited hugely from the ECB’s expansionary policy. Now the ECB is to stop its policy of bond buying – and later push up official interest rates. This will increase the cost to the State of borrowing money. How significant this rise will be is unclear. But after years of the State borrowing at rock bottom rates, things are about to change.