Interest rates internationally are on the way up. Both the US and Britain have recently announced increases and the next move in euro zone rates will also be upwards - the only question is when it will be announced? So how come Irish mortgage interest rates are falling? The answer, of course, is competition. The banks and building societies have been trying to persuade us that they were drawing up strategies for cutting borrowing costs for some time now and that the entry of the Bank of Scotland into the market has merely been a catalyst. The facts suggest otherwise.
The Irish institutions have been doing very nicely out of the domestic market, not fully passing on the benefits of lower wholesale market interest rates over the past year or so. Their excuse was that they were trying to protect savers and that if borrowing rates fell, so too would savings rates. The reality was that they were protecting their profits. The traditional economic theory of competition suggests that if a group of companies are making excessively large profits out of a market, then sooner or later they will be undercut by competition. And this is just what has happened. Bank of Scotland entered the market offering a basic variable mortgage rate of 3.99 per cent; it is no coincidence that AIB has now cut its rate to exactly the same level and that Bank of Ireland has chosen to undercut slightly with a move to 3.95 per cent.
By responding in this way, the two big banks will hope that Bank of Scotland will get little business and will not target other areas of the banking market here. Bank of Scotland, however, has indicated that it will continue to compete aggressively for market share. Some of the smaller domestic financial institutions, meanwhile, face a squeeze on their profits and the need to reassess their strategic approach to doing business. In time, the mortgage price war may even provide the catalyst to a further consolidation of the market here through mergers and acquisitions. Whatever the outcome of this competition, it can only be good news for consumers.
It may be a British institution which is providing the new competition, but it is the advent of the euro which has allowed it to happen. Bank of Scotland can borrow money at relatively cheap rates in the giant euro wholesale money market and then lend it on in Ireland. Other overseas institutions may also choose to enter parts of the market here, taking the same approach. Once competition starts in a particular sector, then it tends to take hold quickly. The aviation sector has been transformed by the entry of Ryanair and other low-cost airlines, while telecommunication costs are tumbling as competition intensifies. In time the move to a single currency will bring even greater cross-border competition in banking and financial services across Europe.
In the short term, the Irish financial institutions will be worried that competition may spread to other areas of the market. Already competition is increasing in the credit card market, for example, and many other areas of the financial market - ranging from personal loans to investment products and business services - will also face a shake-up in the years ahead; the only question is how quickly it will happen. In hindsight, the banks and building societies here may regret that - after the euro arrived last January - they did not move more quickly to lower mortgage rates, as this would have made the Irish market less attractive to a foreign invader.