The European Central Bank surprised many by introducing a rate hike of half of one per cent in July.
Given that the European Central Bank has not raised interest rates in more than a decade – and bearing in mind the alarming rate of deterioration in the Eurozone economy’s growth prospects – speculation centered on a modest 0.25% increase.
However, the regulator appears to have firmly set its sights on controlling inflation in the Eurozone above all else.
“Price pressure is spreading across more and more sectors,” European Central Bank President Christine Lagarde said after announcing the rate hike last month.
“We expect inflation to remain undesirably high for some time.”
Indeed, it has remained undesirably high. According to the latest figures from the European Union’s statistics agency, Eurostat, prices across the eurozone rose at a record rate of 9.1% in the year to August.
It has heightened fears that inflation may become an integral part of the economy and there are expectations of worse in the future.
Although oil prices have fallen recently, European gas prices have been on the rise.
They are now about 10 times higher than their average level over the past decade.
Stockbroker Davey said this week that Ireland’s inflation rate is likely to hit double-digits in the coming months.
Economists at US bank Citi have forecast UK inflation to reach 18% early next year.
This amount of inflation – if it occurs – is likely to recur across the Eurozone.
No doubt he was playing with the considerations of the ECB Governing Council members ahead of the upcoming rate-setting meeting next Thursday.
Where in the past the bank had given some sort of indication of how it would move – a practice known as “forward guidance” – they have now abandoned it in light of the rapidly changing inflationary environment.
From now on, Christine Lagarde said at a meeting last month that the bank would make its decisions on a “month-by-month, step-by-step basis” and would be “data-driven”.
So, to some extent, we’re in the dark about what the ECB is about to do, but some members seem to have made up their minds on the data already.
Isabelle Schnabel, a German economist and member of the European Central Bank’s Governing Council, said inflation expectations have not changed since the last rate hike, noting that she favors another sharp rate hike.
Dutch central bank chief Klaas Knott said he is in favor of another 0.5% increase and possibly a 0.75% increase at next week’s meeting.
Others said a three-quarter point increase should at least be up for discussion.
However, the ECB’s chief economist and former Governor of the Central Bank of Ireland, Philip Lane, argued this week that the ECB should raise interest rates at a “steady pace” which appears to suggest it will not support a 0.75% increase.
He said he thought it would be best to move in “smaller increments” over the coming months, giving more time to see how the economy is progressing.
If the European Central Bank chooses to raise interest rates by 0.75%, it will be the first time the borrowing rate has risen by this margin since the euro was created in 1999.
Prior to July, the borrowing rate had not increased by 0.5% since the mid-2000s.
It is an indication of the scale of the inflationary problem facing ECB policy makers at the moment.
However, this would not be a left move in the current rate-raising cycle globally.
The US Federal Reserve has made two consecutive increases of 0.75% in recent months with a repeatability this month.
So, a 0.75% rally here is definitely out of the question.
What does that mean for mortgages?
Aside from tracked mortgage holders – who automatically take a hit from interest rate increases – major bank lenders refrained from raising interest rates on their floating and fixed rate products after the European Central Bank announced a rate hike in July.
Avant Money, which has among the cheapest rates on the market here, recently announced that it was raising its rates for the second time this year ranging from a 0.3% increase on its three-year fixed rate – up to 2.25% – to a full percentage on long-term fixed rates of up to 30 years.
Its variable rates have also increased.
ICS Mortgages announced another 1.25% increase on its floating rate products last week, which followed a decision by the lender to cap the size of new home loans at two and a half times income.
Finance Ireland has also raised the prices of its fixed-price products in recent months.
While the exact size of any future move from the ECB is unclear, one thing we can say with some certainty is that interest rates will rise further in September and lenders are almost certain to pass that on to their floating rate clients and possibly some of their fixed rate products as well. .
The full 0.75% increase – if delivered and passed – would add about €100 per month to the average mortgage of €250,000, according to Alison Veron, managing director of Switcheroo Mortgages.
However, she said, the biggest shock is likely to be for those near the end of the fixed rate period and to the lender’s standard variable interest rate (SVR), which for some lenders is as high as 4.5%.
A full 0.75% increase would cause this rate to move above 5%.
“Over the past few years, many clients will have short-term fixed rates of around 2.25% which will mature over the next year. And when they do, they may experience a jump in interest from 2.25% to 5.25%,” said Ms. Veron.
I calculated: “For the average mortgage client, this would be an increase of 400 euros per month or approximately 5,000 euros per year.”
The logical thing is to fix again or even switch providers, but some may struggle to prove they can afford a mortgage with a new provider on the back of cost-of-living increases and limited wage increases, Alison Veron points out.
That could see many fall into the trap of what she called the “SVR trap” which she said could be financially devastating for people who are already struggling.
“Customers facing this predicament can see a total cost of living increase of €8,500 per year than they did a year ago,” she said.
She urged those with fixed interest rates to consider the option to break and re-fix to give them a longer fixed term.
In some cases, the provider will not charge a break fee. However, it is necessary to check with them first.
What about trackers?
Most mortgage holders have been good trackers for many years.
With the ECB’s base rate at or near zero since the middle of the last decade, tracker service has been very cheap by historical standards. This is now changing.
From this month, they will pay a premium of 0.5% over their previous price.
Joey Sheehan, Head of Credit at MyMortgages.ie and author of Mortgage Coach has made some sums on it.
With a borrower of €300,000 owed on a mortgage with a 1% tracking rate, with 20 years remaining on the term, they could have had monthly installments of €1,379 so far.
“A 0.5% rate hike would increase this to €1,447 – an annual increase of €816, or €16,320 over 20 years,” he calculates.
At least another 0.5% can be expected in the next week, bringing the mortgage tracker up to 2% – or a full percentage increase in a few months.
By Mr Sheehan’s calculations, “a 1% increase in the ECB’s benchmark interest rate will increase monthly payments to 1,517 euros, an annual increase of 1,656 euros or 33,120 euros over 20 years.”
How high can prices go up?
At the beginning of the year, the European Central Bank’s interest rate watchers had started to raise the interest rate by 0.25% by the end of the year with the possibility of returning the deposit rate (then -0.5%) to zero.
That has already been achieved by July and with speculation focused on a 0.75% hike next month – and with two more rate meetings taking place before the end of the year – the deposit rate could be above 1% by Christmas.
According to the more “hawkish” members of the board of directors, the deposit rate could be closer to 2% by then with the borrowing rate trending toward 2.5%.
“The inflation problem in Europe is so big at the moment that I think it is our duty to raise interest rates every six weeks until the moment of stabilization of inflation,” Dutch Governor Claes Knott told Dutch national radio station NOS last week.
In 2008, inflation rose to 4% and the European Central Bank raised interest rates to 4.25%.
Inflation at 9% – and possibly rising – makes it difficult to predict what rates may end.
The most “pessimistic” elements on the ECB’s Governing Council, including Philip Lane, are urging restrictions.
They are calling to step back and look at the bigger picture.
In the context of recession or economic slowdown, consumer and business demand will fall, acting as a lag in inflation itself.
In this scenario, it can be argued that the ECB should move more slowly. After all, when they raised interest rates in 2011, they had to reverse the increase within months.
The outcome of next week’s meeting will be very telling. If the ECB chooses to raise interest rates at the higher end of expectations, it will signal that hawks are winning the inflation debate and more sharp rate hikes can be expected for the rest of the year and into next.
The era of cheap money is truly over – for the foreseeable future at least.