Since the beginning of this year, the European Central Bank (ECB) has signaled a tougher anti-inflationary policy and the end of more than a decade of ultra-loose monetary policy. To combat the fallout from the 2008 financial crisis and the Covid-19 pandemic, central banks pumped literally trillions of euros into the global financial system while keeping interest rates low in an effort to support sluggish growth. It’s all about change. Now the enemy is inflation, which is currently at a record high of 8.1% in the euro zone and its highest level in 38 years of 7.8% in the Republic. To counter this, the ECB announced on Thursday that it would start raising rates from next month – which would make borrowing more expensive – while ending its asset purchase programme.
How much will prices increase?
Following a meeting of the Governing Council of the ECB in Amsterdam, the bank announced that it would increase its key rate by 0.25 percentage point from July 21, the date of its next meeting, while ending its long-standing bond buying program starting July 1. This will be the first rate hike in 11 years. This represents a radical change in monetary policy. This increase will raise the ECB’s main deposit rate for commercial banks by -0.5% and increase the ECB’s refinancing rate by 0%. Perhaps surprisingly, the ECB also said it would raise rates again in September, and perhaps with a larger margin. Ahead of the meeting, central bank governors from several eurozone countries floated the idea that the ECB might take a more hawkish stance by announcing a 0.5% hike. Perhaps it was just shadow boxing to ensure that the ECB, the least reactive of all major central banks, acted decisively. “If the medium-term inflation outlook persists or deteriorates, a larger increase will be appropriate at the September meeting,” the board said. Markets are expecting even more aggressive action, predicting 135 basis point hikes by the end of this year, or a rise at every meeting from July, with some moves exceeding 25 basis points.
Will it stop soaring prices?
This is a difficult question to answer given the uncertainty surrounding energy prices in general and the fallout from Russia’s war in Ukraine. Some also argue that since the Eurozone is a net importer of energy, the current surge in inflation is actually imported inflation, i.e. inflation over which monetary policy has little control. . Nevertheless, with inflation at over 8%, four times the ECB’s 2% target rate, the bank was forced. ECB Chief Economist Philip Lane, however, has publicly stated that it would take a significant change in the outlook for inflation to justify a 50 basis point hike, which some more hawkish members of the board are calling for. The fear is that raising interest rates too quickly risks triggering an economic slowdown or even a recession rather than simply dampening price increases. Many fear that the eurozone is already heading into recession because of the war in Ukraine. As Robin Brooks, chief economist at the Institute for International Finance in the United States, has said, Tweeter: “The euro zone is entering a recession. Inflation is yesterday’s concern. Rising interest rates will in theory limit price growth, but rising borrowing costs will hamper growth. It’s a delicate balancing act.
How will interest rate hikes affect consumers here?
Those with trailing mortgages or variable mortgages will see an almost instant increase in their monthly repayment as lenders pass on the rate increase. “For someone with €200,000 remaining on their 20-year tracker mortgage – currently paying a 1% margin – they are looking at an increase in repayments of around €45 per month versus a 0.5% increase,” manager of communication on price comparison site Bonkers Daragh Cassidy said. “If you are an average first-time buyer borrowing €250,000 over 30 years at an average rate of 2.78%, a 0.5% increase would add around €70 per month to your repayments if you are variable rate,” he said.While these sums are not huge, Mr Cassidy warned that if ECB rates were eventually to return to more normal levels – 3%, for example – a €250,000 mortgage would cost more than €400 more each month, while a mortgage of €500,000 would be an additional €800 per month.This is based on the average rate in Ireland dropping from the current 2.78 per cent to 5.78 per cent.This, combined with higher prices in general, has the potential to trigger a major shock to the cost of living.With higher interest rates on the short to medium term horizon, many financial experts are now advising potential home buyers to opt for fixed rate contracts.