It started in the US. Talk of big falls in interest rates across the big economies had taken hold and led to big gains in equity and bond markets. It also signalled a better 2024 for borrowers – at least for those on tracker rates and perhaps more generally as other borrowing offers improved.
But in recent weeks surprisingly high US inflation figures have led to one of the most dramatic changes in market mood in recent years, with expectations of a 1.5 percentage point cut in American rates this year now altered and markets pricing in perhaps just one reduction in September.
This week Jerome Powell, chairman of the Federal Reserve, the US central bank, said there was a “lack of further progress“ towards its 2 per cent inflation goal. This has knocked on to less confidence about the extent of cuts by the European Central Bank (ECB) as well – though the key message for Irish borrowers is not to panic. So let’s look at what has happened in the US and what it means for Europe. And for Irish mortgage holders.
1. A big change in the US: The extent of the change in US interest rate expectations has been significant – and surprising. The catalyst for this shift, says economist Simon Barry, has been indications of continuing strength in the US economy in general and in its labour market in particular and of a stalling in progress on reducing inflation. Recent data suggest that the “last mile” in getting inflation down to the 2 per cent target is proving difficult, with the rate rising to 3.5 per cent in March.
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Earlier expectations of six quarter-point US interest rate cuts this year have diminished to one or two. A big rally in equity markets that took hold last October stalled in early April – as ever with markets, analysts argue about why but most feel changed expectations on interest rates is a key factor. Still, most investors expect inflation to ease and US interest rates to be cut: it is a case of “rate cuts delayed, not cancelled”, according to the latest monthly outlook from UBS, which expects a quarter-point Fed cut in September and another one in December. And markets were reassured to some extent by what Powell said on Wednesday and particularly his forecast that inflation would fall this year, even if the decline is slower and more uncertain than had been hoped.
2. What does this mean for Europe? As expectations changed in the US, market bets on the extent of ECB rate cuts has changed too. Earlier this year investors expected a reduction of 1.5 percentage points in ECB rates this year – this has now been pared back to just over 0.75 of a point. That would mean three quarter-point reductions rather than six, though it must be said that the earlier expectations always looked a bit high. Despite the changed mood, however, investors still expect the ECB to start cutting interest rates at its next policy meeting in early June, with a quarter-point reduction, meaning it would be likely to move ahead of the Fed.
According to Barry, ECB president Christine Lagarde has made clear the ECB is dealing with a different outlook but has pointed out that what happens in the US also has a wider impact across the world. This week euro zone inflation came in at 2.4 per cent in April and wage pressures are also less than in the US. Core inflation, excluding oil and food, has been a bit above ECB expectations, but fell to 2.7 per cent last month. On balance, the ECB is expected to move in June, having signalled as much at its last meeting. But the data in the run-up to the June meeting will be closely watched. And beyond that, while further ECB cuts are expected, there is more nervousness about how quickly they will happen.
The precise implications of the ECB moving before the Fed and interest rate trends diverging are being debated. One possible impact is the euro weakening against the US dollar – potentially pushing up EU import prices and inflation. Higher US growth – supporting higher world growth – would also be an argument for euro zone rates not falling as fast. And this week, data showed the euro zone economy likely to skirt recession this year, with growth in France and Germany a bit ahead of expectations. But the euro zone economy is still sluggish and some ECB governors have turned the argument on its head, saying what is happening in the US actually increases the case for ECB cuts, as higher US interest rates will slow international growth.
There is no “right answer” to this question, but Bank of Ireland chief economist Conall Mac Coille has pointed out that the Fed and the ECB have diverged before and there is no reason they cannot diverge again. He believes the impact of potential exchange rate movements on euro zone inflation from diverging interest rates on both sides of the Atlantic is unlikely to be significant.
3. What does this mean for Irish borrowers? Changed expectations mean ECB interest rate falls could be a bit slower than expected and what is happening in the US could be used by more cautious members of the governing council to slow the pace of decline. But both Barry and Mac Coille point out that the ECB deposit rate at 4 per cent is well above what is considered a neutral level – one that neither stimulates nor acts to slow the economy. And so there is plenty of scope for interest rates to fall, even if the precise timing of this remains uncertain.
The current high level of interest rates and their highly restrictive impact on growth are no longer needed, according to Barry, in order for the ECB to keep inflation moving towards its target. And so, barring some big US-style data surprise, a cut in June is anticipated, with further reductions as the year goes on.
These will feed directly through to tracker mortgage holders, who benefit automatically as ECB rates are cut, with their repayments usually falling the following month. An initial, probable cut of 0.25 of a point may seem small compared with the 4.5 point rise they have suffered since the summer of 2022. But the good news is that further reductions can be anticipated later this year and into 2025. The bad news is that interest rates will not go back to where they were in the run-up to and during the pandemic. A tracker rate in the mid 3 per cent range might perhaps be anticipated if the ECB does move its key rates back towards neutral levels.
For other borrowers, reductions due to ECB moves may be slower to appear. In particular, variable rate and fixed interest rate offers did not rise to match ECB increases – and so they will not fall by as much either, However, there is good news from another source. The recent move by Bankinter, owner of Avant Money, to increase its presence here has led to them reducing three-, four- and five-year fixed interest rate offers significantly. The new rates, coming into effect on May 3rd, are in the 3.6 to 3.95 per cent range depending on their term and loan-to-value ratio. This is well below the 4.5 per cent plus offers from the mainstream banks for borrowers who do not qualify for their more attractive green offers.
Higher rates from the traditional banks for non-green mortgages are likely to fall now, too. And for those who do not want to switch banks there are variable offers from the main lenders that allow them to wait and see for a few months, taking little risk by doing so.
So for new borrowers, or those rolling off old fixed rates, the options have increased, whether they qualify for green rates – or one of the better BER rates from Bank of Ireland under its new structure – or whether they don’t, in which case the new Avant offers are attractive. It looks like a world where most borrowers will be able to get a loan in the 3.5 to 4 per cent range. In the current environment that does not look too bad. The gains that might have come from a faster ECB rate reduction look like they are being made up by the other key factor in interest rate setting – competition.
