Cut in interest rates now possible

A reduction in official interest rates is possible this week, according to Mr Oliver Mangan, bond economist at AIB Group Treasury.

Irish inter-bank interest rates have been rising steadily over the past weeks, despite the promise of large scale cuts later in the year.

The Central Bank is still lending money to Dublin banks at 6.19 per cent at its weekly "repo" tender. But that money is limited, and only the large banks get a sizeable chunk and even then it is often less than their needs.

The other official lending rate of the Central Bank is the short-term facility, or STF, which is now at 6.75 per cent. This is normally seen as the highest possible rate in the market and is used by the Bank as lending of last resort. It has practically fallen into disuse over the past few years as rates have generally traded substantially below it.

However, according to Dr Dan McLaughlin, chief economist at ABN Amro, one month money, traditionally used to set retail and mortgage rates is now around at 6.63 per cent.

This means the larger banks can borrow at 6.19 per cent and immediately lend the money out again at 6.63 per cent, making a completely risk-free profit at the expense of international and smaller banks.

"The Bank cannot allow this to go on for very long as it is against the orderly running of the market" Dr McLaughlin said. `'It is effectively giving away risk-free profits."

And according to Mr Mangan the only real way out is for the Bank to cut the STF to 6.5 per cent or just below, allowing the smaller banks access to cheaper money.

He added that the Bank will wait to see how the market develops over the rest of the week. But if the redemption of some Government debt does not pour enough money into the system it may be forced to act.

The weekly management meeting on Friday would be likely to take the decision and a cut could be announced on Friday afternoon.

However, he added, the Bank would be anxious to portray this as a technical move rather than an interest rate cut.

But it will also be conscious of the difficulty of persuading the public that this is not the beginning of rate cuts and risk feeding inflationary pressures in the economy.

In the past a cut in the STF would have been a signal that mortgage rates were to come down. But this time, Mr Mangan, insisted all the players would realise this is not the case.

In any case, current retail rates would normally be consistent with the one-month inter-bank rate at around 6 per cent so interbank rates would have to fall reasonably substantially before there would be a fundamental reason for a retail cut, he said.