What does the ECB's rate hike mean for consumers?

What does the ECB’s rate hike mean for consumers?

The European Central Bank has confirmed what it has been strongly suggesting for some time now.

The bank will start raising interest rates for the first time in over a decade next month.

So what does this mean for consumers and mortgagees across the block?

First move

The ECB has come under fire for what many believe has been its slow reaction to the inflation environment.

Euro area prices rose at an annual rate of over 8% according to the latest figures.

This is more than four times the target interest rate of 2% that central banks want to keep inflation at.

The bank had stuck to the argument that inflation was transient and had more to do with supply chain problems that arose from the pandemic and the reopening of economies.

That argument was more or less abandoned after the Russian invasion of Ukraine.

But the debate then shifted to the level of interest rate hikes that would be appropriate in the context of an economy that could risk contracting with a war raging outside the door.

It has given an indication of how it intends to proceed now.

The bank will start cautiously and raise interest rates by 0.25% at its meeting in mid-July.

We knew more or less that it would come and a further interest rate increase in September was expected.

However, it has changed the parameters somewhat for what comes in September.

It has said that if the inflation outlook persists or deteriorates, “a larger increase will be appropriate at the September meeting”.

It came as a bit of a surprise.

In addition, it is anticipated that a “gradual but sustained path with further interest rate hikes will be appropriate” in addition.

Will my mortgage rate go up in July?

It is likely that the bank will first and foremost focus on the deposit rate, which is -0.5%.

This will almost certainly be reset to zero in September.

This is the interest rate that financial institutions receive for investing excess money with the ECB (even if they have been charged for it in an era of negative interest rates).

The rate that affects our loans is currently zero.

It is now a question of when they choose to start raising that interest rate.

In the light of the new guidance given by the bank when it comes to the September meeting, it may start to postpone that interest rate from then on, or it may even raise it in July in line with the deposit rate.

As soon as that price goes up, the cost of variable and traceable mortgages will rise.

ECB President Christine Lagarde

What difference would it make for my tracker?

Joey Sheahan, Head of Credit at MyMortgages.ie and author of Mortgage Coach, put some numbers on it.

A borrower who has € 300,000 outstanding with a tracker interest rate of 1%, with 20 years left, would currently have a monthly repayment of € 1,379.

“An interest rate increase of 0.5% would increase this to € 1,447 – which is an annual increase of € 816, or € 16,320 over 20 years,” he explained.

“An increase of 1% in the ECB’s reference rate would increase the monthly repayments to EUR 1,517, which is an annual increase of EUR 1 656 or EUR 33 120 over 20 years,” he added.

Trackers are no longer issued so anyone who takes out a mortgage at a free variable interest rate recently would have a variable interest rate.

Mr Sheahan used the example of a mortgage of a similar size at a variable interest rate of 4.25% with 30 years remaining of the term.

Such a mortgagee would have monthly repayments of € 1,475.

“An interest rate increase of 0.5% would increase this to € 1,564, which is an annual increase of € 1,068 or € 32,040 over 30 years,” he said.

“An increase of 1% in the ECB’s reference rate would increase the monthly repayments to EUR 1 656, which is an annual increase of EUR 2 172 or EUR 65 160 for 30 years.”

What about fixed interest rates?

Some fixed interest rates have begun to move upwards in recent months as the cost of “long-term” money has begun to rise.

That process is likely to accelerate now that the ECB confirms that its bond buying program will end and it signals higher interest rates.

But there is still very good value to be found in fixed-rate mortgages and there has been an increase in exchange activity in recent times.

“We are seeing a steadily increasing number of movers / second-time buyers seeking mortgage approvals with long-term flexible fixed rate options. This follows the trend set by existing mortgagees trying to protect themselves against the imminent future rate hikes,” said Trevor Grant, chairman of the Association of Irish Mortgage Advisors. AIMA).

Rachel McGovern, Director of Financial Services at Brokers Ireland said significant savings could be made by switching providers and fixing.

“Over the past 10 years, we have come from the fact that the average fixed interest rate is as high as 4.85% to today, where the average fixed interest rate is 2.59% on new fixed interest rate agreements,” she pointed out.

She also suggested exploring the possibility of committing to longer periods with fixed interest rates of up to 30 years now available.

“Long-term fixed interest rates, relatively new in Ireland, have provided the best value in the Irish market in recent years,” she said.

How far are interest rates likely to go?

Central bank statements always contain plenty of winding space.

And so they should because the situation can change very quickly and they must be able to change course to deal with new scenarios.

But it now looks like we are on a definite path towards a time of more expensive money.

The main lending rate in the UK has already been raised to 1% by the Bank of England and the US Federal Reserve has moved interest rates to a similar sounding board.

And they probably have not stopped yet.

It would not be unreasonable to suggest that we are on a similar path here.

Austin Hughes, chief economist at KBC Bank Ireland, referring to current CSO inflation figures, said the pace of price increases showed no signs of slowing.

“With fuel prices moving even higher in early June and the consequences of higher transport costs and global supply problems that have not yet been fully realized, it is likely that Irish inflation has not yet peaked,” he explained.

“It seems likely that total inflation could push up close to 9% and even threaten 10% depending on the keys to global energy markets,” he added.

He added that any return is likely to be modest and may be slow to materialize, especially in light of spillover effects to areas such as mortgage rate hikes.

On the other hand, some point out that the bank may be in too much of a hurry to signal interest rate hikes at a time of such uncertainty in the overall economic outlook.

“The possibility of a larger increase from September increases the risk of an ECB policy mistake,” said Bill Papadakis, macro strategist at Swiss bank Lombard Odier.

“Conditions in the euro area are different. GDP is still lower than before the pandemic, wage growth is much more subdued and growth is threatened by the war in Ukraine. The crucial thing is that the war is fueling higher energy prices, which in turn is driving high inflation in Europe. More “costly energy eats away at consumers’ real incomes, undermining growth, which is likely to suffer if the ECB moves on with an aggressively tighter monetary policy.”

If that happens, the ECB may have to re-evaluate how aggressively it is raising interest rates in the medium term.

In the short term, interest rates will only go in one direction and that is upwards.

How far? Nobody really knows.


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