Don't bet the house on the euro

What will the launch of the euro by banks and large corporations next year mean for mortgages? Irish interest rates are expected to fall by about 2 per cent by the end of this year. A similar fall in mortgage rates can reasonably be expected.

A fall of 2 per cent in variable mortgage rates from their current level of around 7.5 per cent would mean a saving to mortgage holders of about £1.16 per £1,000 per month on a 20-year mortgage. A mortgage of £80,000 may cost about £93 per month less, about £1,100 per annum. By all accounts, this is a great saving for the mortgage holder, particularly for the first-time mortgage holder in today's market. It's as good as any giveaway or "payback" budget.

The worst thing a mortgage holder could do would be to plan their finances to depend on a permanently low mortgage rate after the arrival of the euro next January. This is not just because there is no guarantee that the full extent of a 2 per cent fall in wholesale interest rates will be passed on to mortgage holders. Why? The banks at it again? Perhaps, but logic would dictate that deposit rates would fall by a similar amount too, and this may not be commercially possible, given how low deposit rates already are. It has even been suggested that the Central Bank and the Department of Finance might be happier if mortgage rates did not fall, since a fall would be more likely to fuel inflation.

But those are relatively minor points. Assuming that mortgage rates do fall next year, will that fall mean permanently lower mortgage interest rates? Are our present mortgage rates of about 7.5 per cent as high as we are likely to see them for the future? What chance is there that mortgage rates in Euroland will exceed today's Irish pound rates? Is now as bad as it gets?

It is a common assumption, hotly debated, that the euro will be at least as strong a currency as the deutschmark has been. So, it could be expected that euro interest rates and therefore our mortgage rates after January 1st, 1999 are unlikely to be higher than German interest rates have been. The euro will be a big world currency, maybe even large enough to challenge the status of the dollar as a reserve currency.

A quick look at historical German and US three-month interest rates shows there have been many times when they have exceeded the current Irish three-month interbank rate of 6 per cent. In five out of the 13 years between 1986, inclusive, and now, German interest rates have exceeded 6 per cent. They rose to 9.7 per cent in 1991, largely as a result of German unification. A variable mortgage rate of 1 per cent over that wholesale rate, 10.7 per cent, would lead to monthly repayments of about £10.12 per £1,000 per month on a 20-year loan or £809 per month on an £80,000 mortgage. Of course , plenty of us remember such rates.

We can recognise that German unification and the financial trouble it caused was unusual. A further look right back to 1960 shows German rates exceeding 6 per cent for periods in 1961, 1965-66, 1969-71, 1972-75 and 1979-83. Some of these levels were caused by oil price rises. But the fact remains that the mighty D-Mark had rates which significantly exceeded our own present rate for substantial periods since 1960. They even touched 14.5 per cent in 1973. The same goes for the world's strongest currency, the dollar.

From 1981 right through to 1990, the US wholesale rate exceeded 6 per cent. Again, there were special factors, such as the second oil crisis and the Reagan years expansion in defence spending. Those rates were not typical of historical US rates. But can we be so confident that even historical aberrations like those rates imply cannot happen to the euro?

This is a fairly simple presentation of facts, which economists and others could pick at. And yes, past performance is not necessarily a guide to future performance. The future cannot be easily extrapolated from the past five, 10 or 20 years.

But the past still matters. Financial markets factor historical price variations of many financial instruments into the calculation of their riskiness and therefore their value. The past shows the extent of the variations which few people would have predicted. which have actually occurred. It is a big warning against assuming that we shall never see 6 per cent, 7 per cent or even 12 per cent mortgage rates again. So, whatever you do, don't bet the house on the euro.

Oliver O'Connor is an investment funds specialist.