Welcome to the new era of low interest rates. The Central Bank has finally bowed to the inevitable and started the reduction of Irish interest rates towards the levels prevailing in France and Germany. The key money market interest rates was reduced by 1.25 of a percentage point yesterday to 4.94 per cent and must fall a further 1.6 points before the end of the year, assuming there is no further reduction in continental EU interest rates in the meantime.
The reduction in Irish interest rates is part of a move amongst all the peripheral members of the single currency, moving their interest rates down towards core euro levels. Earlier this week Spain announced its first reduction, while Portugal followed yesterday and only the fall of the Italian government is now likely to delay a move to reduce rates there.
How much will borrowers benefit? Yesterday the Irish Permanent, the State's biggest mortgage lender, was quickly out of the traps, announcing a 0.75 of a point cut in its key variable mortgage rate to 5.75 per cent and a similar cut in the rates paid to savers.
The benefit to mortgage borrowers from this cut alone will amount to £22.61 on a £50,000 mortgage. And the cost will further reduce by the end of the year. By the time we enter monetary union next January, short-term interest rates on the wholesale market here must be equal to those prevailing in other euro zone countries. A single currency area must have the same short-term interest rates as otherwise investors could borrow in one area and lend in another and make a profit.
For some time the Central Bank here held off cutting Irish interest rates, in the hope that rates in France and Germany might rise, meaning that rates here would not have as far to fall to converge to the other euro members.
But the recent weeks of global financial crisis have put paid to the hopes of higher rates in Europe. Falling interest rates across the world means that the euro zone is likely to start its life next January at the rates now prevailing in France and Germany - meaning a short-term wholesale market rate of 3.3 per cent.
This means that the Central Bank here will probably announce two more reductions over the rest of the year as it brings the current Irish market rate - now 4.9 per cent - down to the 3.3 per cent level.
There has even been some speculation that the recent market turmoil could lead core euro rates even lower, although at the moment further reductions from the 3.3 per cent level look unlikely , for this year at least, although there could be pressure for more reductions next year. It is not clear precisely how much of the total fall in wholesale money market rates will be passed on to borrowers by the financial institutions.
The banks and building societies point out that they will not be able to reduce rates to all savers to match the total fall in wholesale market rate - after all the rate paid on many demand deposits is already well below 1 per cent.
This means that while the benchmark wholesale rate will fall by around 2.9 percentage points - 1.25 points and a little over 1.6 points to come - the reduction in the rates charged to borrowers and paid to savers will be somewhat less.
In total, the variable mortgage rate facing most borrowers is likely to fall by around 2 percentage points, yielding a monthly saving of close to £60 a month on a £50,000 mortgage. Meanwhile, as Mr Martin Walsh, head of lending at the EBS points out, the ease with which institutions will be able to raise funds in the new euro market will mean a whole new era of competition for fixed rate mortgage products and a much greater availability of longer-term fixed rate products for periods of 10 to 20 years.
Savers will suffer, however, with the rates available on most bank and building society products falling, although the institutions will not be able to reduce demand deposit rates much from current levels. It remains to be seen precisely how the banks and building societies will manage to hold on to deposits and cut rates charged to borrowers, while at the same time protecting their profit margins. The best protection for the consumer in this situation is competition; with all the institutions scrambling for market share in both the savings and lending markets, borrowers will be besieged with new offers, while the financial institutions will try to retain some attractive rates to hold on to their deposit base.
However, small savers with demand deposit accounts may find that the already paltry return on their deposits is further eroded, increasing the pressure on them to seek longer-term savings products offering higher returns. Financial institutions argue privately that in an era of low interest rates they simply cannot make money out of small deposits; the question now is whether they will impose new charges on small savers or introduce new measures such as a minimum size on deposits.
The impact of the rate cut on the overall economy will be to provide further stimulation. The extent to which this will be offset by the international economic crisis remains to be seen. What is clear is that low interest rates are likely to be the order of the day for a prolonged period.
