What will the ECB do with interest rates on Thursday and what will it mean for Irish borrowers?

What is expected at Thursday’s meeting of the ECB’s governing council?

The ECB is certain to increase interest rates. It had previously said the increase would be 0.25 of a percentage point, but reports now say that a 0.5 point rise will also be considered. The inflation rate has increased more quickly than the ECB has anticipated, reaching 8.6 per cent across the euro zone in June. Its interest rates are still very low, of course. Even if there is a full half point increase in all its key rates, the deposit rate the ECB pays banks for overnight deposits would rise from minus 0.5 per cent to zero per cent and its key refinancing rate would increase from zero now to 0.5 per cent. The ECB is well behind other central banks who have already increased their rates — UK rates are at 1.25 per cent and US rates at 1.75 per cent and both are due to rise again shortly.

What is the point of increasing interest rates at all?

Higher interest rates are the traditional tool used by central banks to control inflation, as they slow economic growth and the demand for money. But this time inflation is rising mainly because of higher energy prices and other supply side problems. Higher borrowing costs won’t stop this happening, but the idea is that they would make it less likely that inflation would spread and get embedded — managing people’s expectations of future inflation is seen as vital. But if growth slows while inflation stays high then central banks will be in the firing line.

How will the ECB decide what to do?

Well, it had signalled it would move gradually to increase interest rates — and by 0.25 of a point this time. It would not abandon this forward guidance lightly, but talk of a half point rise suggests that more central bank governors are coming around to the German-led view that the ECB needs to get a move on.

What an interest rate rise means for you

Listen | 34:20

The European Central Bank is expected to raise interest rates this week in an effort to dampen inflation. What will the move mean for consumers, mortgage-holders and the economy? Cliff Taylor explains. But first: This week AIB announced it would no longer provide cash services in many more of its branches across the country. The move has angered some customers, advocates for rural services and bank employees. Ciarán talks to markets correspondent Joe Brennan and Financial Services Union general secretary  John O'Connell about the move.

[ ECB to discuss ending negative rates with 50 basis point move ]

Part of its dilemma is that if euro zone growth were to slow sharply in the autumn, possibly due to a cut in Russian gas supplies, then it might find it hard to increase interest rates much further. And the ECB will also worry about the impact of higher interest rates and lower growth on the cost of borrowing for slower growth/high debt countries, particularly Italy.

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What is the outlook for Irish borrowers?

If the ECB increases its main refinancing rates then this knocks on automatically to tracker mortgage rates. Mortgage broker Michael Dowling points out that borrowers get a month’s notice of a rise under their contract. Non-tracker variable mortgage rates may also come under upward pressure though Dowling believes that Bank of Ireland and PTSB — with relatively high rates already — could decide to absorb a small rise without passing it on. AIB, Finance Ireland and ICS have lower variable rates.

Those on fixed rates are by definition protected until the end of their current arrangement — and many have moved to lock in for longer periods. The cost of some new fixed rate offers, notably from newer players, has already increased. New rate offers will start to rise in the months ahead if ECB rates head firmly higher though competition could cause some to hold off for now.

[ Will it pay to switch mortgages and lock into a long-term fixed rate? ]

Darragh Cassidy of comparison website Bonkers.ie points out that mortgage interest rates elsewhere in the euro zone have started to increase in recent months, while they have stayed largely static here. As interest rates here remain well above euro averages, this means a small ECB increase might not be passed on to many consumers. Of course, rates will rise here if ECB rates move on a steady upward track in the autumn.

Anything else to watch?

Oh, yes. The ECB is due to tell the markets about a new mechanism it will use to try to stop market speculation against slower growing and highly indebted member states. Italy is seen as first in the potential firing line here and its cost of borrowing has already risen in recent weeks. The key issues are how the ECB says it will intervene in the market to support the borrowing of countries such as Italy, in what volumes and what conditions will be attached. More frugal northern states such as the Netherlands and Austria will want strict conditionality on budget policy on a country being assisted — but these would be hugely controversial in countries such as Italy. With economic growth slowing and interest rates going up, this is yet another dilemma for Christine Lagarde’s ECB.