The days of super-low interest rates seem numbered

Cliff Taylor: tracker mortgage rates will rise in tandem with any ECB rate hikes

The ECB looks set to signal in the months ahead that the period of extraordinary stimulus will slowly draw to an end.

The ECB looks set to signal in the months ahead that the period of extraordinary stimulus will slowly draw to an end.

 

The European interest rate cycle is turning. The days of super-low interest rates are not quite over yet, but borrowing costs look set to start rising next year. The ECB is going to start preparing the way for this in the months ahead, assuming the euro zone economic recovery stays on track.

Interest rates have remained lower for longer than we might have expected, but it is well to remember that a zero base rate and a central bank pumping money into the economy through purchasing bonds is not the “norm”.

Stimulus

The ECB looks set to signal in the months ahead that this period of extraordinary stimulus will slowly draw to an end. This looks likely to clear the way for the ECB to increases its key short-term interest rates some time next year. In the meantime, longer-term interest rates on financial markets, already off their lows, will drift higher in the months ahead, if the euro zone recovery remains on track.

When ECB rates rise, those on tracker mortgage rates will see their mortgage repayments rise in tandem with any official hike. Standard variable mortgage rates would also be likely to rise, though as costs here are already above the EU average it is not clear if they would rise exactly in line with ECB increases. Much will depend on the state of competition in the Irish market at the time.

Longer-term fixed rate mortgage offers could start to edge up earlier than an ECB rise, as these are priced in relation to market interest rates which typically move ahead of official rates. Those wanting to lock in their mortgage rate for a few years might thus be well advised to examine the options sooner rather than later.The difficulty is, of course, that the pace and extent of the rise in variable rates remains uncertain and so judging the value in the fixed rate market involves some guesswork.

Guidance

Minutes of the ECB’s December meeting, published on Thursday, suggested that the central bank’s key policy-making committee believes that its guidance to the market about its policy stance might need to be “revisited” early this year. In the subtle world of central bank language, this is important. The context is what the national governors and senior ECB executives on the committee called “ recent indicators pointed to a continued robust and increasingly self-sustaining economic expansion.”

The euro zone economy was starting to move towards full capacity more quickly than expected and this should start to push up the rate of inflation, according to the minutes.

The scale of growth in Europe – and indeed internationally – is striking. “Trends in the euro zone economy have improved significantly over the last year or so as evidenced by strongly above-trend growth rates and a notable decline in the unemployment rate, with figures this week showing the jobless rate at a near nine-year low,” according to Simon Barry, chief economist at Ulster Bank in Dublin.

The ECB has already started to pare back its purchases on the bond markets, he pointed out – now €30 billion a month – and the more the economic signals improve, the stronger the case is to continue this “ gradual normalisation.”

Programme

The ECB is due to continue its bond buying programme until September at least and had indicated it will not start to increase interest rates for a period afterwards. The latest data, and Thursday’s minutes, will increase speculation that bond buying will indeed be ended this year and the ECB may become more explicit about this shortly. Once that happens, the debate will be when, not if, interest rates will head higher.

The big uncertainty is inflation. The ECB’s job is to bring inflation close to 2 per cent and its big fear in recent years has been that the euro zone economy would lapse into deflation.

While the council expressed confidence that inflation would start to rise as the euro zone economy approached full capacity, there is simply no way to forecast this with accuracy. For the moment the ECB is predicting that the inflation rate will only rise gradually to a modest 1.7 per cent by 2020.

Internationally, rising inflation has been the missing link in the economic recovery. In the US core inflation, excluding volatile factors such as energy, is just 1.4 per cent – despite unemployment at a 17-year low of 4.1 per cent – and this is causing debate at the US central bank, the Federal Reserve Board (Fed), about the appropriate pace of interest rate increases this year.

The Fed pushed up rates three times in 2017 – its base rate is now 1.25 to 1.5 per cent – and has signalled the same for 2018. US long-term bond interest rates have risen sharply this week as markets there reckon that, despite low inflation, the interest rate cycle is only heading one way - upwards.

The euro zone recovery is a few years behind the US, of course. There will now be much debate in the months ahead not only about when the first ECB rise will come, but of how quickly euro zone rates will then rise and how far they will go.Trends in growth – and particularly inflation – will determine the answers.

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