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                                  Interest rates


 The ECB and Irish rates

Interest rates for borrowers and savers as set by banks in Ireland are determined by a range of factors, including competition in the market, the risk appetite of lenders, the risk weighting of specific loans and the cost of funds for the banks, but the floor for short term rates is set by the ECB

Euro area banks are required to hold reserves with the ECB and historically the latter controlled short term interest rates via the rate (refi rate) it charged on its  Main Refinancing Operation , paid by  banks to borrow money for a week. In the past Irish banks offered  mortgages linked to this rate (Tracker mortgages) and a third of outstanding loans are of this type, with an average rate of 1.05% as the  refi rate was cut to zero in March 2016.

In recent years the ECB has been supplying massive amounts of excess liquidity to the banking system and so short term rates are now closely linked to the Deposit Facility, the rate  the ECB will pay  on deposits from the banking system. This was cut to a negative rate in June 2014 and since September 2019 has stood at -0.5%.

The ECB cannot control longer term interest rates but can influence them by means of Forward Guidance ( indicating to the market how long it expects to keep rates where they are) or by buying Government and Corporate bonds (Quantitative Easing) which seeks to impact longer rates in a more direct manner.


Rate Outlook (17 August 2021)

The ECB has effectively raised it inflation target (it is now 2% from 'close to but below 2%')and announced at its July meeting that it intends to keep rates at their current level or lower until three conditions are met

1.Inflation reaches 2% 'well ahead of the end of its projection horizon' (which is 2-3 years)
2.Inflation is deemed to remain at the target 'durably' for the rest of the forecast horizon.

3.Underlying inflation is seen to be consistent with  maintaining the 2% target in the medium term.

Inflation has accelerated in recent months, largely due to higher energy prices, and stood at 2.2% in July, so one might argue that condition (1) above has been met, The ECB believes this inflation upturn to be short-term , however, and core inflation is certainly still very low, at just 0.7%. Consequently the Governing Council still expects inflation to be 'well below' target in the medium term and will maintain its 'persistently accommodative monetary policy stance'.

Market expectations also reflect this is and indeed longer term  money market rates have fallen over recent weeks.5-year fixed rates, for example, had risen to -0.24% in June but are now down at -0.38%, and 10-year rates are again negative after turning positive a few months ago. Forward money rates also indicate that the market does not expect the ECB to raise rates until late 2023 , with 1-month money priced to remain negative out till early 2028.

Expectations can  and do change of course and the ECB may shift its stance if inflation remains well above target for a longer period than envisaged in their forecasts but for now it appears that rates will stay low for even longer.