Tracker rates in Ireland became the norm in the early noughties,linked to the ECB’s refinancing rate (refi rate) with a spread, which averaged around 1.1% . Consequently the ECB’s current refi rate of 4.5% translates to a Tracker rate of 5.6%, although for years borrowers paid only 1.1% given the refi rate was at or near zero from 2014 to July 2022.
The refi rate is the rate banks pay to borrow from the ECB and used to be the main instrument used by the Bank to control short term interest rates in the euro area. However, that changed when the ECB started to flood the market with excess liquidity in an attempt to get inflation back up to the 2% target and so the Deposit Facility rate (the rate the ECB pays banks for deposits) became the effective operational rate . The spread between the refi and deposit rate has varied over time but since 2019 has been set at 50bp, with the current deposit rate at 4%.
That is set to change from mid-September according to an announcement setting out the ECB’s proposed new framework for guiding euro rates .The issue arises because excess liquidity is falling and the ECB is looking ahead and to the kind of operational framework they will adopt when liquidity is tighter. They have decided that the Deposit rate will still be the key driver of rates but as liquidity ebbs money market rates may well start to rise above that floor.Banks will be able to borrow all they need at the refi rate, so that will put a ceiling on rates but the spread between the two will fall to 15bp from the current 50bp in order to maintain a tighter corridor.So even if the deposit rate in September was still 4% the refi rate falls to 4.15% and Tracker rates decline by 35bp. Of course the market is actually priced for cuts to the Deposit rate by then, to say 3.5%, which if it materialises would mean tracker rates will fall by 85bp to 4.75%. The market is currently priced for a cycle low in the deposit rate of 2.25%, which implies a Tracker rate of 3.5%..