Are borrowers going to be forced to pay more for their loans because the European Central Bank thinks inflation is still too high? It looks like we are facing into another interest rate hike for the tenth time in 18 months. Stephen Kinsella, Professor of Economics at the University of Limerick and chief economics writer with The Currency joined RTÉ Radio 1's Morning Ireland to discuss. (This piece includes excerpts from the conversation which have been edited for length and clarity - you can hear the discussion in full above).
It's likely the ECB will indeed hike interest rates again at its meeting today, says Kinsella. "There is a couple of factors leading into the decision. The first is that inflation is still too high. It was 10% and above this time last year and it's around 5% now. It's falling rapidly obviously but it's still 3 or 4% too high. The ECB is legally mandated to keep inflation at around 2%."
"On the other side, the major economies of the Eurozone, like Germany, are actually slowing down. It looks like industrial production there is not going too well. There's a couple of other factors, not the least of which is the war and how long it's dragging on. But it looks to me like they will probably increase it one last time. Or signal that they'll pause in this month and then try for an increase in October. That will be the 10th increase in about 18 months, which is an incredibly fast, steep increase, as everybody on a tracker or a variable mortgage will know. The interest rate increases, for our economy, they're not great." Kinsella says it's likely that we're at the end of the "interest rate increasing cycle".
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From RTÉ Radio 1's News At One, Eurozone energy prices are down 3%, but food prices are up 10%
What if inflation doesn't go down despite interest rate hikes?
"If there's some unexpected event, the ECB has a very large way to climb up. It can simply increase interest rates again and again and again," says Kinsella. "There are other tools at its disposal, but it can simply say to firms that want to pass on cost increases, "keep doing this and we will increase our interest rates". It can say to households, "look, in economies like Ireland's that are at risk of overheating, you guys keep going and we will keep increasing interest rates"."
"So it's not just about what's happening today, it's about the bank guiding people's future behaviour and saying, "if you do this, we will do that". And it can respond to events very, very quickly. As we've seen during Covid-19. During Covid-19, the ECB was pumping out hundreds of billions over a mere number of months. So it's able to move extremely rapidly if it needs to. So if we see a very large, unexpected event like a big change in energy prices, that's exactly what they'll do. And they do have enough, very substantial firepower to be able to do that," says Kinsella.
Read more: How much is inflation taking from your salary?
The ECB is of the view that governments should be reining back on cost-of-living supports, which is interesting in the context of Ireland's Budget 2024 coming up and the billions in government coffers. What would the ECB think? "I don't think the ECB has publicly commented on the budget as it's coming up, I don't think they would think it's appropriate. But I can't imagine that they are delighted with the idea of an economy where the unemployment rate is just over 3%, where things are going very well, from a macroeconomic perspective of course - and there are things that aren't going well in different sectors, like housing - but the economy here is growing very, very rapidly. So I think the idea of adding billions to the spending power is probably not great if you're the ECB and your job is to try to rein in inflation," he says.
Are there countries at risk of entering into recession?
"France and Germany. One of the things we look at very carefully is industrial production, so how much stuff is getting produced. A lot of this is being produced on working capital, which comes from banks. And every time you go to the bank for working capital, the bank expresses the loan that you're going to pay at the interest rate that it sees from the ECB, plus whatever its cost of capital is. So the German industrial production would be markedly slowed because they're borrowing pretty much constantly, similarly to France," says Kinsella.
"So as the German or French economy slow down, that means their satellite countries like Austria etc. will also slow down. So that provides a robust case for keeping interest rates where they are now. Because interest rates take a little bit of time to feed in to the real world. The financial market adjusts instantly, but you don't see a change in interest rates until you actually go to the bank to ask for a new loan and that might take months, or sometimes even years."
