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, with the floor for short term rates 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. The ECB introduced an additional bond purchase scheme in 2020, the PEPP, to counter the impact of the pandemic on economic activity and inflation.
Rate Outlook (14 March 2022)
The ECB has effectively raised it inflation target (it is now 2% from ‘close to but below 2%’) and announced at its July 2021 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 sharply in recent months, initially due to higher energy prices but more recently to broader drivers, largely on the supply side, consistently exceeding ECB expectations, and this prompted a significant change in ECB rhetoric and now policy. The PEPP has now ended and net asset purchase will cease at end-June, with a quarter point increase in rates pre-announced for the July meeting. Another will follow in September, although that could be half a point, with further tightening signalled.
Although longer dated money market rates have already risen sharply retail mortgage rates have not as yet risen in Ireland,perhaps due to the large scale of excess deposits in the main Irish banks. That will change though and Tracker rates will begin to increase in line with the ECB’s refinancing rate, the first increase since 2011.