Interest rates will rise – it is just a question of when

Thursday 21 August 2014 18.58
ecb

Many households have managed to pay their mortgages due to the substantial cut in ECB rates.

Central bankers in the euro zone, UK and US frequently adjust interest rates in unison.

That is not due to a herd instinct, but when conditions in one region merit higher or lower rates similar circumstances are often occurring elsewhere.

It does not always happen that way.

However, when the Bank of England makes noises about increasing interest rates it is worth asking the question whether the euro zone far behind.

In Ireland, the emerging recovery has been partly helped by a policy of exceptionally low interest rates. Last June the European Central Bank continued to reduce rates cutting to an unprecedented 0.15%.

Lower borrowing costs have eased pressure on Irish households – many of which are snowed under with high levels of debt.

Borrowers with tracker mortgages have seen a substantial 4.1% drop since the crash began in 2008. Those with standard variable loans have not been so lucky. Of course lower rates also mean reduced returns for savers.

In the UK this week, board minutes from the Bank of England revealed two members of its monetary policy committee had voted to hike rates.

The bank’s Governor Mark Carney, an Irish passport holder, has said “rates will need to start to rise” from their record low of 0.5%.

Analysts think that is likely to happen next year. Members of the monetary policy committee will examine wages, employment and economic growth before deciding when to tighten rates.

While growth in Britain has been the strongest of any of the G8 countries so far this year, the picture in the euro zone is more lacklustre.  Growth in the currency bloc was zero between April and June.

As Ireland picks up the pieces after the crash, the economy here is expected to expand much more quickly, possibly by 2.5% this year – although that turn-around follows a dramatic plunge in economic output.)

Inflation in the euro zone is running at 0.4% – far below the level at which the European Central Bank is comfortable.

There are a number of other measures which show conditions in the currency bloc remain sluggish.  With anaemic growth and weak inflation there is little incentive for the ECB to hike rates for the time being.

But when the recovery happens across the euro zone and inflation creeps up, Frankfurt will tighten monetary policy.

Many Irish households, which have been hit with higher taxes and wage cuts, have managed to pay their mortgages due to the substantial reduction in ECB rates.

For many, higher rates may be difficult to handle because their disposable incomes have diminished significantly during the crash.

It is not scaremongering to say rates will rise at some point in the future.

The question for the Central Bank, the Government and the banks here is what they will do to ensure a new group of householders don’t slip into arrears.

It is clearly going to be some time before Frankfurt increases rates.

And it would be reassuring to know the Irish authorities had at least considered the issue while they have the luxury of time.

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