Interest rates for borrowers will shortly be on the way up, following this week's decision by the European Central Bank to increase its key rate by 0.25 of a percentage point to 3.25 per cent. It is a move which should not cause too much pain to most homeowners; interest rates will still be below the levels of the middle of last year, before the entry of Bank of Scotland to the market led to a round of cuts. However, many borrowers will now be anxiously wondering how much further interest rates will rise in the months ahead and what this will mean for their repayments.
There is no doubt that, if the Central Bank of Ireland was still in charge of interest rates, the cost of borrowing would be considerably higher than its current level. But when we joined the euro zone, we handed over the power to set interest rates to the European Central Bank in Frankfurt. It has maintained a low interest rates level to try to revive growth in the major continental EU economies. Signs of some revival in these economies and fears about the inflationary impact of the fall in value of the euro led to this week's rate increase and further rises are anticipated later this year.
Just how far interest rates will rise is unclear. It will depend on the speed of revival in the main EU economies, the extent to which this leads to inflationary pressures and the performance of the euro. By increasing interest rates in a period of euro weakness, the ECB risked being accused of a panic reaction to the currency's fall. Fortunately for the bank, the euro recovered somewhat after it moved, although it did fall back again late yesterday.
Borrowers should prepare for a gradual increase in interest rates over the balance of this year and into 2001. On the plus side, the prospect of higher interest rates is welcome news for savers and may serve to cool the property market. However, such is the size of loans taken on by some borrowers in recent months that even a modest increase in repayment costs will have a significant impact on their finances.
In this context, the warning yesterday by the Educational Building Society that houses were now a "speculative" asset and that market trends provide a danger to the economy is a timely one. EBS, as an important player in the market, is in a position to know what is going on. It clearly feels that other financial institutions are extending excessive loans. The Central Bank is also known to have warned the banks on a number of occasions to rein in their lending. In a fight for market share, many lenders have been prepared to breach the normal guidelines, leaving both themselves and their customers exposed.
Predictions that the housing market is heading for a painful crash, with a sharp fall in property values, will be seen as overly pessimistic. Interest rates should only rise gradually and from a low base, and the economy continues to grow strongly. However, the warning from the EBS and the dangers in the market should not be ignored. The Government has acted to improve the supply of housing, but these measures will take some years to work. It is essential that the planning process does not hold up the development of new housing projects unduly. The Government needs to do all it can to make sure more houses come on to the market as speedily as possible, as well as pressing ahead with its affordable housing measures.