No rate cuts may endanger discounts on mortgages

Generous discounts for new mortgage borrowers may be abandoned in the autumn if the Central Bank is still holding off on rate cuts.

The discounts were introduced by the lending agencies in anticipation of interest rate falls in the run-in to monetary union. But rising inflation has put back rate cuts and convinced the money markets that reductions are still some time away.

The one-month interest rate - the key rate for setting retail mortgage rates - rose to above 6.5 per cent yesterday. Under normal circumstances this would begin to trigger a series of interest rate rises. And lending institutions warned yesterday that if it persisted, special interest rate discounts may be discontinued.

According to Dr Dan McLaughlin, chief economist at ABN Amro, there is increasing negativity on the prospects of rate cuts any time soon.

But because interest rates must fall by the end of the year, the banks and building societies are reluctant to raise them only to have to lower them again.

According to Ms Barbara Patten, head of marketing at Irish Permanent the State's biggest mortgage lender, circumstances are unusual in the run-up to the single currency. "Rates at this level would normally trigger a round of mortgage rises but we cannot do that at the moment and it is making inroads into margin which is only sustainable in the short term."

Mr Peter Kelly, chief dealer at First National, the high level of inter-bank rates is making the discounts more expensive to run. "We are keeping rate under review and if the one-month continues to be this high we could actually see the discounts being cut."

However, according to Mr Martin Walsh, head of lending at EBS, given the level of the one-month rate, he expects lenders with a heavy dependence on wholesale funds to be reviewing their base rates. "But with Irish and German rates certain to coverage, lenders will be reluctant to take the lead in this area."

According to Dr McLaughlin, Irish wholesale interest rates have been picking up all week. Indeed there is such pressure in the market for higher rates that the Central Bank actually has injected around £1.8 billion into the market in a bid to increase liquidity and keep rates lower.

Some observers are still hoping that the Bank will decide to start cutting rates soon on the basis that it will not want a small number of large reductions coming on top of one another. Irish rates have about 2.5 percentage points to fall to meet German levels.

However, in all public statements recently the Bank has insisted that it will leave cuts for as long as possible. It is worried that early cuts could fuel demand even further. With inflation running at 2.5 per cent and credit and mortgage growth both over 20 per cent that could be dangerous. As Dr McLaughlin notes. "Rates must come down: January 4th 1999 now looks the best bet."