Interest Rates Start To Fall

It may have been signalled for some considerable time but the scale of yesterday's interest rate cut by the Central Bank will…

It may have been signalled for some considerable time but the scale of yesterday's interest rate cut by the Central Bank will have taken most people by surprise. The reduction of 1.25 percentage points in the Bank's key wholesale money market rate is one of the largest in the history of this State and will be welcomed as very good news for most borrowers. The resulting 0.75 percentage point cut by the Irish Permanent will mean a saving of over £22 per month on a £50,000 mortgage and further substantial reductions are inevitable by the end of the year.

However, savers will suffer and one group who stand to lose out as we enter a new era of low interest rates, are small deposit holders. Financial institutions argue that in a low interest-rate environment they can no longer make any profit from minding the funds of small savers. However they must strive in the months ahead to find an equitable way to deal with this group, mindful of the large profits they make from their overall operations.

Pressure on the Central Bank to cut interest rates has intensified in the past week as the downward trend in international rates accelerated. The Bank is responding to the convergence of Irish interest rates towards the lower German and French rates before monetary union begins next January. With no possibility now that German and French rates will increase before the end of the year, moving Irish interest rates down to these levels means that a further significant reduction in Central Bank rates is inevitable before the end of the year. Indeed, a further reduction in the core European rates cannot be ruled out later this year or early in 1999.

These very sizable interest-rate cuts will raise some concerns about a possible overheating of the economy. The reduction will provide a further boost at a time when the economy is already enjoying record levels of growth and consumption. The fear is that this will trigger new inflationary pressures in the economy. For all that, these dangers have been reduced somewhat by the international economic downturn, which, if it gets any worse, could have serious implications for the outlook here. The recent signals that the inflation rate, as measured by the consumer price index, may have peaked, are also encouraging.

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And the recovery of the pound in value against sterling will also help to hold down import prices.

There could be other positive effects. An interest rate which puts more money in people's pockets may help to ease the pressure on public-service pay. But there is one sector - the property market - where lower interest rates could have serious consequences. On past evidence, interest-rate cuts can lead to fresh bouts of house-price inflation, more than eroding the benefits to borrowers of lower mortgage rates. The Bacon measures - especially those targeted at investors - have succeeded in bringing a modicum of calm to a dangerously overheated market. But this area must remain a focus for policymakers who have a responsibility to do what they can to stop a further sharp rise in house prices, which would leave many people vulnerable in the event of an economic downturn.