After six years of interest rates sitting at rock bottom, it came as a bit of a jolt when the European Central Bank started raising rates last summer.
And the regulator certainly hit the ground running with a full half a percentage point increase to its key rates in July on what was its first rate hiking venture in over a decade.
That saw the ECB’s deposit rate going back to zero and the main borrowing rate to 0.5% in one swift move.
Admittedly, it wasn’t a huge surprise. In fact, the ECB had come quite late in the day to the rate hiking party – most of its counterparts had already started raising rates earlier in the year.
But it has lost no time in playing catchup – the July increase was followed with two successive 0.75 point hikes and another half point increase in December.
Now, the ECB – as well as its global peers – has come to a delicate phase on its rate hiking path.
If it raises rates too aggressively, it could tip the euro zone into recession.
Move too gently, and it could negate the work it has done so far in keeping a lid on soaring inflation.
Having peaked in October, eurozone inflation has fallen for two months in a row now, according to the official data.
From 11.1%, the annual rate of price increase eased to around 10% in November and 9.2% in December.
But that’s still around 4 and a half times the ECB’s target inflation rate of 2%.
It takes a while for interest rate increases to work their way through, so are there early signs that the rate hikes are now working or is it simply down to the fact that energy prices have fallen significantly in recent months?
If it is the former, do they just sit back now and let the rate hikes introduced to date do their work, or do they stay the course and raise rates even further?
All the indicators point to the ECB continuing to raise rates.
And recent signs that the euro zone economy might be a bit more resilient than had been thought may indeed strengthen that resolve.
“We need to raise rates more,” ECB chief economist Philip Lane told the Financial Times quite explicitly in recent weeks.
Professor Lane – a former Governor of the Central Bank of Ireland – had previously been regarded as one of the more ‘dovish’ members of the bank’s Governing Council who would have favoured taking a more considered approach to rate hikes, giving them time to take effect.
However, the more ‘hawkish’ view has taken over in more recent months, it appears.
“Hawkishness is no longer a characteristic of just a few ECB members; it is now the mainstream view,” analysts at Dutch bank ING said in a recent note.
In short, expect more rate hikes ahead.
Another hike looks all but inevitable next Thursday and the ECB may not stop there.
“Another 50bp (basis points) (0.5%) rate hike looks like a done deal and another 50bp rate hike at the March meeting even looks highly likely,” the ING analysts said.
That would see the deposit rate going to 3% and the main borrowing rate to 3.5%.
“As long as core inflation remains stubbornly high and core inflation forecasts remain above 2%, the ECB will continue hiking rates,” ING added.
Inflation is expected to rapidly ease this year with much of it as a result of the “base effect” from falling energy prices, but it’s expected that the rate of price increase will stay above 3%.
“The question is how do you get from mid-threes at the end of 2023 to the 2% target in a timely manner,” Philip Lane said in the FT interview, leaving the door open to further rate hikes later in the year or even into next year.
What does it mean for tracker mortgages?
Tracker mortgage holders get the full brunt of each rate hike.
In the event of a half point increase later this week, the ECB base borrowing rate would move to 3%.
Tracker mortgages are named as they track the ECB rate as it moves up or down, but with a margin attached, usually of around a percent or more.
That means most tracker holders could be looking at a rate of around 4% or more on their mortgages from later this month.
There has been a renewed focus recently on whether tracker holders should ditch their trackers and lock-in to a fixed rate, some of which are now coming in around the 4% mark.
For anyone with a margin of 1.5% or more on their loan and if they have only a few years left on their mortgage, it might be worth considering.
But once a tracker is renounced, it’s likely gone forever. A decision on forgoing a tracker should be taken with the advice of a broker or financial adviser.
What about fixed and variable mortgages?
While lenders across the eurozone responded promptly to each of the rate hikes, the banks here appeared to adopt a ‘wait and see’ approach.
As a result, Ireland went from top of the leaderboard for most expensive mortgages across the euro zone last summer to below the average now.
They have, however, raised rates on multiple occasions at this point.
That has seen pricing on fixed rate mortgages moving closer to 4%, with lower rates available on properties with a lower loan-to-value ratio or those that have a higher energy efficiency – so-called green loans.
The variable rate mortgage – which appears to have gone out of vogue in recent years in favour of fixed rates – is starting to look attractive again at certain lenders.
At AIB and its subsidiaries, the variable rate stands at just above 3% or even below that for a lower loan to value.
However, they too are likely to increase as the base rate continues to move upwards.
Other lenders in the market – which rely on the financial markets for their money – have been quicker to raise their pricing making them less competitive now.
Do higher rates mean I’ll get more for my deposits?
This appears to be the payoff for borrowing rates staying relatively competitive.
The banks are crammed with deposits right now after a saving spree by households during the pandemic.
Although the ECB deposit rate is at 2% right now – which is helping to push up the interest income that banks are earning – they’re not passing much of it on to depositors.
The main banks currently offer deposit rate of between 0 and 0.75%, with Permanent TSB offering 1.25% annually on its five year savings product.
However, there hasn’t exactly been a clamour for higher deposit rates from customers who appear on the whole to be happy with the security that a bank deposit account brings.
That may change gradually as deposits and savings get wound down and deposits become a more valuable resource for the banks.
How high could rates go?
That is the question.
With two more half percentage point increases in prospect, a base rate of 3.5% looks likely by the early summer.
The Federal Reserve in the US has raised rates there to an upper limit of 4.5%.
There is speculation that the Fed may have to cut rates by the end of this year and the question has been posed as to whether the ECB could find itself in a similar situation.
Once it has raised rates to a position where it can bring inflation back to around 2%, it becomes a fairly delicate balancing act of doing too much versus not doing enough.
For most of the past decade, the ECB fought excessively low inflation.
Some argue that the underlying conditions have not changed so ultra-low price growth could eventually return, forcing the ECB to backtrack on rates.
In his recent FT interview, Philip Lane wasn’t convinced that this was in prospect.
“I don’t think the chronic low-inflation equilibrium we had before the pandemic will return,” he said.
Higher rates could be here for the long term, it appears.