MORTGAGE RATE RISE: ANALYSIS: Trichet confirmed the mortgage wheel has turned and rates are on the increase again
THE PEOPLE who control Europe’s purse strings speak in a code that only the keenest students of euro zone monetary policy understand. Yesterday, as he announced a 0.25 percentage point increase in European Central Bank (ECB) base rates – the first in nearly three years – governor Jean Claude Trichet said the bank would continue to monitor inflation “very closely”.
The phrase “monitoring closely” used to be seen as a sign the bank was two months off a rate hike, while “very closely” meant such a move was on the cards within a month.
People concerned about the impact the latest round of ECB increases will have on their take home pay should not be unduly concerned that Trichet’s use of “very” yesterday means another increase will happen in May. ECB watchers say “very” has lost some of its significance in recent years.
That is not to say more rate increases aren’t coming down the tracks. And soon.
Senior ECB figures are on the record saying there could be two more rises in this year, which will mean a lot of pain for many Irish mortgage holders. And it is pain that some will struggle to bear.
For nearly two years, anyone in possession of a precious tracker mortgage has been able to sit back and watch those on Standard Variable Rates (SVR) bear the brunt of our broken banks’ desperate attempts to stem their losses – losses that arose in no small part out of their reckless issuing of trackers at the height of the boom.
A person on an SVR with Permanent TSB has seen their interest rate climb from 2.69 per cent in May of 2009 to 5.19 per cent ahead of yesterday’s ECB rate rise, while someone with EBS has seen their rate go from 2.63 per cent to 4.43 per cent over the same period.
All the while, holders of those trackers – who make up some 60 per cent of the Irish banks’ total residential mortgage books – enjoyed a mortgage honeymoon as the ECB kept rates at an historic low of 1 per cent.
That honeymoon came to an end yesterday with Trichet confirming that the wheel has now turned and rates are on the increase again.
Within an hour Bank of Ireland had issued a press release saying it was upping its tracker rates by a quarter of a point from next Wednesday. The other banks will follow suit – although National Irish Bank was quick to make a virtue yesterday of the fact that it had no intention of increasing rates. However, it is not a major player in the Irish mortgage market.
While those on trackers have benefited from historically low interest rates for nearly two years, they needed those low rates more than their peers. They were generally the people who bought at the height of the property madness that gripped the State in the early part of this century and mortgages of well in excess of €300,000 are common.
But what will the increase mean? For every €100,000 owed on a 30-year tracker mortgage of 1.5 per cent plus the ECB rate, a quarter point increase adds just over €13 to the monthly repayments.
It may not sound like a whole lot but it means that a person with a €300,000 mortgage has to find a further €40 monthly or €480 each year as a result of the ECB move.
Two more similar-sized increases before Christmas will see that person’s annual mortgage outgoings increase by more than €1,300. But the increases may not stop there. In July 2008, at the top of the last cycle, the ECB rate was 4.25 per cent and, while there is no suggestion they will reach that point in the medium term, they could. If such a nightmare scenario did come to pass, people on the tracker outlined above would have to find close to another €500 a month just to pay their mortgage.
“It is probably going to be the first of several moves but how close those moves come together and how aggressive those moves are is something that remains to be seen,” says financial analyst and mortgage adviser Karl Deeter. “Unfortunately there is only a lower limit on interest, there is no upward limit and in theory rates can go as high as they want to.”
Austin Hughes, chief economist with KBC, says a return to the rates of 2008 seems “outlandish at the moment” although he tempers that by saying “it can’t be entirely ruled out”. In a “doomsday scenario” that saw international commodity prices sky rocket, the ECB would keep rates rising aggressively to control inflation.
He says the ECB is looking for a rate that would match a steady rate of economic growth.
“At a point in the distant future, you are looking at a rate of 3 per cent, it could be a little bit higher or a little bit lower but I think that is the region they are aiming at.” He believe the ECB is likely to get to 2 per cent before pausing “to see where the world is at that point”.
A series of ECB hikes will inevitably see the number of non-performing loans increasing significantly. Once the cushion of low mortgage rates is removed many people, already stretched to their financial limit by wage cuts and tax increases, will be tipped into arrears.
According to the most recent data from the Central Bank the number of residential mortgages in arrears had jumped by over half in 2010 and one in 10 mortgages is either in arrears or has been restructured due to financial distress.
“If you look at our total number of mortgages and the number that are in distress versus where we probably should be, it is clear that thus far the low rates have has actually served us well and saved the country from having a much larger problem,” Deeter says.
If unemployment continues its upward cycle and economic growth remains weak, then the problem of arrears and defaults will accelerate at an even faster pace which will put further pressure on the banks and will stymie growth still further.
Yesterday’s increases will also hit holders of standard variable rate mortgages (SVR). Again.
According to the chief executive of the Irish Brokers Association, Ciaran Phelan, people on SVRs “could be subject to higher increases as the banks use this opportunity to further boost their margins on these customers”.
“With some SVRs now double comparable tracker rates, we would again warn tracker customers from being tempted off these products. A typical €300k 25-year SVR mortgage is now costing more than €500 a month more than a comparable tracker,” he said.
“Yesterday’s move makes the ECB the first major developed economy central bank to hike rates and the decision will cement its reputation as a single-minded inflation fighter,” economist Nick Kounis says. “The hike is unwelcome for peripheral countries, but arguably the core member states were in need of this move some time ago. In that sense, the timing of the increase is a balancing act, which is part and parcel of the one-size-fits-all monetary policy,” he adds.
Speaking at a press conference after the rate hike was announced, Mr Trichet dismissed suggestions that it would increase pressure on Ireland and other periphery euro zone states, and said the decision was not intended to help or hurt any one country but to maintain price stability to benefit “directly and indirectly all 331 million citizens in the single currency area”.
However, another leading economist, who declined to be named, said that while peripheral countries such as Ireland, Portugal and Spain are in serious financial difficulty and do not need an increase right now, the ECB is not focused on them when it comes to rates.
He said the increases were being aimed at putting manners on Germany. “It is like the apocryphal mammy who tells the teacher that if her child is bold, to hit the child beside them as that will calm them down.”
And in this scenario it is Ireland and the other bold boys in the class who are about to get the wallop.
