The Irish Times view on rising interest rates

A quarter point increase and maybe more is on the cards this month

The backdrop to the publication on Monday of the Government’s Summer Economic Statement is provided by a rapid change in the cost of borrowing. The price of raising longer-term State finance has jumped by around two percentage points since the start of the year and may increase further. Financial markets have been anticipating changes in European Central Bank (ECB} short-term interest rates and July is the month when this process starts.

The ECB has just ended its programme of Government bond buying – a vital support to EU states during Covid-19. Although it will continue to reinvest the proceeds from these investments, an important test now lies ahead for sovereign borrowing markets. The ECB is widely expected to start increasing interest rates on July 21st, when its governing council meets. More will follow in the Autumn.

Like other central banks, the ECB must strike a difficult balance. Inflation has been largely driven not by rapid economic growth but by rising energy prices and supply problems in other markets, notably food. Higher interest rates do not address this directly but are designed to stop inflation spreading and to underline the determination of central banks to get it under control. The risk, of course, is that this comes as economic growth is slowing worldwide and that higher interest rates compound the effects.

The ECB faces another problem, unique to its situation. The slowdown in growth and the change in ECB policy threatens to cause pressures in euro sovereign debt markets, with Italian borrowing costs rising sharply. The ECB has promised to develop an instrument to deal with this but doing so is not easy. A key issue is what budget conditions to impose on countries which get such support. This is hugely sensitive politically.

So the ECB faces two difficult balances to strike. Recent comments by its president, Christine Lagarde, highlight that the bank’s position has changed fundamentally in recent months. A gradual rise in interest rates is promised but Lagarde says that more " determined” action may be needed. A quarter point increase is on the cards this month, though a half point rise cannot be ruled out. A further half point increase in September is widely expected.

This changed environment has significant implications for the Government. Borrowing costs remain low by historical standards but the days of zero interest rates are gone. Ireland needs to be careful given the risk of pressures on EU government bond markets.

Fortunately Irish households have run down their debts since the financial crash and are in a much better position to cope with higher interest rates. The problem, of course, is that this comes on top of many other cost-of-living pressures.