The first ECB rate rise in over a decade was universally expected later this year and it is now likely to be announced on the 21st July. The most recent data has led to the capitulation of the more dovish Council members, with its combination of record low euro area unemployment, another fresh high in the headline inflation rate , at 7.5%, and a big jump in the core rate, to 3.5%.
The market has been pricing in higher rates for some time although expectations are volatile and at the time of writing longer term rates have fallen from the recent highs, albeit with 1-month euribor still priced at 1.25% by end 2023, or over 1.75% above the current level. For this year, three quarter point increases are fully priced in, taking rates well into positive territory by Christmas.
Higher money market rates will eventually feed through into retail rates but the impact on Irish households may well be less painful than in the past. First, rates are much lower than at the beginning of previous tightening cycles – the average rate on outstanding mortgages is currently 2.45%, including a variable rate average of 2.16%. Second, household debt here has been falling for 14 years and is now down to 98% of household disposable income, against well over 200% at the peak of the Tiger era. Third, in the aggregate households now have far more cash and deposits than debt, with the gap widening to €54bn in the final quarter of 2021.
A fourth factor relates to the mortgage market itself which in the past was largely based on variable (floating) rate debt, meaning a relatively quick pass-through from wholesale rates to most borrowers. In recent years that has changed as around 85% of new loans are fixed, with the majority over three years. Over time, the proportion of outstanding mortgages on variable rates has fallen and is now down to 50%, against over 90% when the ECB last raised rates in 2011.
Irish fixed rates are generally on a shorter term than the EA norm and so over the next few years many will have to revert to a new fixed rate or to a variable and both are likely to be higher, although given the hit to real incomes from inflation (now 7%) a few years respite will be welcome.
Although an ECB rate increase looks inevitable now, the impact on Ireland, at least initially, will also depend on which rates the ECB choose to adjust. Short- term money market rates are currently tied closely to the ECB deposit rate, at -0.5%, and that will move up in order to push up market rates. The refinancing rate is zero and the spread between the two rates has varied historically, from 0.25% to as wide as 1%, so it is not a given that the refinancing rate will also move up in July, although on balance that appears most likely.
When the refinancing rate moves may be open to debate but not the impact here as 30% of outstanding mortgages are on Tracker rates i.e. at a fixed spread over the refinancing rate. That percentage has been falling steadily as mortgages mature (it was still as high as 50% in 2015) and the average rate has been extraordinarily low for some time (1.05%) but if the refinancing rate does rise by 0.75% by year-end that will increase Tracker rates by the same amount.
One final point . Two major mortgage lenders are leaving the market which all things equal will reduce competition for loans, although a number of new niche lenders appear to be picking up market share in terms of new lending. How mortgages are funded is key though, and the remaining banks have a huge pool of excess deposits, paying zero or even negative rates , to call upon, against other lenders who are solely reliant on market rates .Ultimately higher market rates will be passed through but the timing may vary depending on that funding mix; new Irish mortgage rates rose in March, as across the EA, but with a difference in that here new fixed rates were unchanged and the increase was in variable rates.