New economic data has shown euro zone inflation fell to 2.9 per cent last month, from 4.3 per cent in September. Together with figures estimating that euro zone GDP edged 0.1 per cent lower in the latest quarter compared to the previous three months, this has led to speculation that the European Central Bank (ECB) may be finished increasing interest rates, after increases totalling 4.5 percentage points since the summer of 2022. Is this the case and what does it mean for mortgage borrowers?
What are the prospects for ECB rates?
With inflation falling and weak economic signals, it would be a big surprise if the ECB went for an 11th increase at its next meeting in December. The US Federal Reserve Board, the American central bank, kept its official interest rates on hold for the second successive meeting this week, thought it warned further rises cannot be ruled out. We may see a similar message from the ECB in mid-December, though unless the data changes direction most market analysts believe that official ECB interest rates have now probably peaked.
Economist Simon Barry said that there had been a marked change in market expectations in recent weeks reflecting a growing conviction that interest rates have peaked and that the next move will be downwards. Markets are also growing more optimistic on the extent of likely cuts over the next 18 months, he said.
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What are the risks?
There are two obvious ones. One is that inflation gets stuck above the ECB’s 2 per cent target, putting it under pressure to increase again. The latest figures show that, excluding volatile energy and food prices, inflation is still over 4 per cent, and the ECB is likely to point to this as evidence that another rise cannot be ruled out at some stage. The second risk that is the situation in the Middle East worsens and oil prices shoot higher, knocking on to higher inflation. However this would also hit economic growth, which would hit demand and reduce inflationary pressures. How this might play out and how the ECB might respond is hard to judge.
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The World Bank published a range of scenarios this week for how oil prices might react to the Middle East conflict. It had previously said the price of a barrel of oil would be around $90 per barrel – Brent Crude is just slightly lower now. Various scenarios it looked out might see this rise, it speculated, to between $110 and $150, the latter in a worse case scenario where oil shipments were disrupted. It is very hard to know how central banks would react to the conflicting economic forces this would create – the world is a lot less reliant on oil than it was in the 1970s when two big oil crises hit, but it is still a vital fuel.
Might the ECB have gone too far in increasing rates?
Yes. Forward looking indicators in areas such as purchasing managers’ indices point to significant weakness in the euro zone. The problem for the ECB is that interest rate policy operates with long lags, so it will be into next year before the full impact of the interest rate increases seen so far is evident. This means, as economist Austin Hughes has put it, the ECB has been driving while looking in the rear view mirror. With fears that the euro zone economy could slip into recession, there is a lot of uncertainty about the outlook.
Is the euro zone drifting into recession?
What about mortgage holders?
If ECB rates have indeed peaked then so too have tracker mortgage rates, which move in lockstep with official rates. The 130,000 to 140,000 tracker holders have seen the highest monthly increases among those with loans from banks and many have switched to a fixed rate. Some nonbank lenders have also passed on increases to variable rate customers, a group of which have been among the worse impacted.
Elsewhere in the market it is not so clear-cut. After Bank of Ireland increased its variable mortgage rate last week, Darragh Cassidy of Bonkers.ie pointed out that – apart from trackers – Irish banks had not pushed up their other mortgage lending rates by anything like as much as the ECB increase. On average Irish mortgage rates have gone up by between 1.5 and 2 percentage points, compared to ECB increases of 4.5 points. So Cassidy warns that further increases of around one percentage point on average might be expected. Those on standard variable rates with the main banks will thus see more increases.
Banks have increased fixed rate offers, too – Bank of Ireland has put its new customer fixed rates up by 1.75 percentage points, for example. These rates are driven by money market interest rates and could also rise further, though new borrowers will hope that competition for business helps here.
All this is relevant for two groups. One are mortgage holders coming off fixed rate contracts who will either have to move to non-tracker variable rates – so-called standard variable rates – or fix again at higher rates than their current loan. About 65,000 borrowers are due to come off fixed rates contracts this year and another 70,000 in 2024. This includes many newer borrowers who have bought at relatively high prices in recent years. Many could face monthly repayment increases of €300 or more as things stand.
The other group are borrowers currently on standard variable rates, of which there are around 165,000, a number which has dropped sharply as large numbers moved to fixed rate since the end of 2018. Many of these are older loans with smaller balances, but nonetheless those who did not fix are now facing increases, even if ECB rates stay put. Cassidy points out that the pressure is now on banks to increase their standard variable rates to maintain their margins as higher interest rates are finally passed on to depositors.
When might interest rates fall?
This is far from clear. Market analysts generally expect the ECB will start to cut in the second or third quarter of next year. According to Barry, recent data has led to more optimism about the timing and scale of reductions. Markets are now pricing in a one quarter point cut as early as next April and believe that there could be a further one percentage point decline in the following year. This is significantly more than had been anticipated up to recently.
Such forecasts are inevitably very tentative and trends in inflation and growth could lead them to change markedly in the months ahead. Any cuts would immediately benefit tracker holders – and lead to a better outlook for borrowing rates in general.
An interesting question is what the average rate will be in the years to come. Over the past couple of decades the direction in interest rates has been generally downwards, leading analysts to speculate that trends such as an ageing population meant that the average interest rate required to keep economies and inflation stable was falling. The last couple of years may lead to this changing – does an ECB deposit rate of 2 per cent, equal to its inflation target – do the job, or might a rate of, say, 2.5 per cent be a more realistic longer-term expectation? As this plays out, it is an important debate for mortgage holders.
