Rate cut demands a new balancing act

The half-percentage point cut in euro interest rates will have to be passed on to borrowers in some shape or form, but demand deposit rates are already at rock bottom and to cut them further would take the return into negative territory in some instances.

Financial institutions now have to decide how to balance the competing interests of savers and borrowers while keeping an eye to their own profit margins.

Usually, financial institutions match cuts on the lending side of their book to those on the deposit side, allowing them to maintain their profit margins.

With little scope to cut deposit rates any further, they are unlikely to announce cuts of a full half-point in lending rates. If other institutions follow Irish Permanent's example and maintain their deposit rates while cutting lending rates by a quarter of a point, they will see the profit margins on their core borrowing and lending businesses fall slightly.

They may have little option but to broadly follow the lead set by the State's biggest lender. The industry's desire to protect depositors is not without an element of self-interest - deposits are an important source of funding for all financial institutions as they do not want to put all their eggs in one basket by having to raise all their money in the financial markets.

For the building societies, in particular, deposits are a key source of funding, and EBS has already signalled that it will pay careful attention to the interests of savers as well as borrowers.

However, the Consumers Association of Ireland (CAI) believes that the banks have been using the excuse of protecting depositors as a smokescreen for maintaining their profit margins.

Mr Eddie Hobbs, finance spokesman for the CAI, calculates that the banks' average gross margin on their mortgage business has increased from 1.6 per cent in the first quarter of 1998 to nearly three per cent in some cases. He also points out that the margin enjoyed by the Irish banks is the highest in Europe.

With EBS no longer setting the pace because of its focus on preserving its savings base, he believes a stand-off has developed in the Irish mortgage market, with all the lenders reluctant to make the first move and cut rates by the full amount of the official reduction.

"The reason for this is that the market is growing hugely and the pressure isn't there because there's room for everyone to make a good living. But this will change when the property boom starts to subside," Mr Hobbs said. Certainly, the latest figures from the Central Bank show that the mortgage market remains buoyant. Residential mortgage lending was up 19 per cent year on year in February, as against 18 per cent in January.

Forecasts yesterday that interest rates are set to remain low - and could even fall further later this year - are set to underpin demand for loans over the rest of the year. New borrowers are already finding attractive offers as the different financial institutions seek to win their business, although affordability of housing looks set to become an even more important issue as the year goes on.