At long last, the European Central Bank is poised to embark on a journey towards reducing interest rates, following a round of ten hikes since the summer of 2022. However, mortgage holders and other borrowers anticipating further cuts as the year advances should keep a couple of things in mind. Firstly, unless there’s a noticeable downturn in Eurozone inflation rates, it’s likely that any subsequent rate reductions will be gradual at best. Secondly, the likelihood of reverting back to the ultra-low interest rates that the world experienced for a decade following the July 2012 lowering of a main deposit rate to nil – a response to the financial crisis – is slim.
We’ve learned from recent history that the financial market’s anticipation of future interest rate trajectories can flip rapidly and dramatically, which underlines why excessive reliance on the global trends of the past months may be misguided. However, it is undeniable that they have been significant. The market had been expecting a series of US interest rate cuts this year, but stronger than anticipated US economic data and persistently high inflation rates prompted a reassessment of these predictions. This situation has impacted the US stock market negatively, despite a recent resurgence due to weaker employment market data re-igniting hopes of rate cuts. Despite this, the consensus among most analysts is that the US Federal Reserve – or the Fed – is unlikely to implement a rate cut until September. They predict a maximum of two cuts this year, with some anticipating only a single reduction, while the more hopeful anticipate three.
The bustling sentiments within the U.S. have incited a debate with regard to the potential disparity between U.S. and euro zone tariffs. However, the European Central Bank (ECB) has insinuated a reliance on euro zone information to sway its decisions. Although there was an increase in the euro zone’s inflation rate to 2.6 per cent in May, as opposed to 2.4 per cent in April, the ECB has hinted at proceeding with a quarter-point reduction today. Despite this, the inflation figures coupled with some indications of a reviving euro zone economy – where wage growth is at 4.7 per cent and joblessness is consistently low – have led the market dealers to ponder over the magnitude of the impending decline in interest rates throughout the year. This matter is undoubtedly pertinent for tracker mortgage bearers especially, who have witnessed a 4.5 per cent augmentation in borrowing expenses since Summer 2022, courtesy of the rise in the ECB refinancing rate from zero to 4.5 per cent, which is the basis for pricing tracker rates.
The question then arises, what is the likely reduction in ECB rates this year? The financial markets are currently wagering on two additional cuts post today. Yet, this would, nevertheless, retain the ECB’s chief deposit rate, presently at 4 per cent, over the 3 per cent threshold by the year’s end. This aspect carries weight given that at such a point, the ECB perceives interest rates to remain in a restrictive domain – effectively to limit lending and ideally to steer inflation downwards. If inflation were to slowly dip to around 2 per cent by the summer of 2025, this would pave the way for further reductions in interest rates into the forthcoming year. Though, if inflation continues to soar, this projection could be unsettled and after a pair of slashes, the ECB might be compelled to maintain the rates for some time. Balancing these interest rate forecasts, which inadvertently bear significant implications on the economy, will be a crucial task for the ECB as it will in turn influence their counter-inflation attempts. Thus, a long-term perspective is essential.
In terms of mortgage borrowers, the crucial factor is the long-term interest rate trend. It’s imperative to understand that there’s no sign of the mortgage rates reverting back to the previous lower rates, unless there’s a significant downturn in the Eurozone economy. Despite potential for this to happen in the distant future, the extremely low interest rates seen in the last decade were a result of subdued Eurozone growth and inflation rates, which fell under the European Central Bank’s 2% objective. Currently, the forecast is that inflation will likely hover around the 2% mark for the foreseeable future. Consequently, banks are not expected to reduce their interest rates back to levels that permitted tracker rate prices to fall between 1-1.5% and locked in fixed rates at 2.5% and below for 3-5 years.
The debate to what degree interest rates might decrease is partially based on a theoretical assumption about the so-called natural interest rate, which is the level at which economic activity is neither stimulated nor hindered. This assumed rate then needs to factor in the contemporary rate of inflation and is therefore expressed as an inflation-adjusted or ‘real’ rate. The exact level of this rate isn’t observable and recent approximations for the Eurozone suggest it could be slightly more or less than the rate of inflation. To put it plainly, should the European Central Bank meet its 2% inflation goal, it’s possible that over time interest rates may decrease towards this level, or at least towards 2.5%, but could only drop further if the inflation rate falls below the 2% target.
In the forthcoming months, it might be witnessed that interest rates take on a downward trajectory. However, it is not anticipated for the European Central Bank (ECB) deposit rate to dip below 3 per cent until the next year, perhaps settling around 2.5 per cent eventually. The knock-on effect of such an occurrence would be to bring tracker mortgage rates down to the vicinity of 3.5 – 4 per cent, from its current level of above 5 per cent. Those with tracker mortgages are accustomed to significantly lower costs, yet the modest repayment history, coupled with the average outstanding balance of €100,000, positions the majority in a sturdy place financially, well into the life of their loan. Also, it could be inferred from the probable ECB rate of around 2.5 per cent that the superior fixed rate deals currently available – situated between 3.5 and 3.75 per cent – offer reasonable value, unlike the remaining fixed rates north of 4.5 per cent, which offer comparatively poor value in this context.
Over the previous year, borrowers taking out fresh mortgages or transitioning from fixed rate loans, who opted for variable loans or a single year fixed term, have encountered advantageous conditions. This trend seems set to continue as fixed rates are improving and poised for further reductions.
Standing as partly symbolic, Taoiseach Simon Harris made it publicly known in the past week that he will urge lenders to act in response to the ECB rate reduction. Prior to the ECB’s decision, some interest rates had already been slashed, and tracker rates are set to effortlessly decline. Despite inconsistent changes with variable interest rates in alignment with the ECB’s rates and despite a few reductions, Taoiseach’s pressure on the lenders remains necessary. However, as the government’s share in banks dwindles, its influence also diminishes. One area that could be put under the scanner is nonbank lenders managing loans owned by investment funds, where interest rates in certain cases are exorbitantly high. Borrowers engaged with these loans have a legitimate reason to feel disappointment with the authorities, who had assured them that they would not be at a disadvantage, thereby necessitating a sustained level of political and regulatory pressure.
It’s important to keep in mind that individuals who hold trackers are set to receive a “bonus” reduction of 0.35 points in September, due to an overhaul of the ECB’s official interest rates. Currently, there is a 0.5 difference between the primary rate or deposit rate and the refinancing rate, which sets the cost of tracker rates. The ECB has announced their plans to shrink this gap to 0.15 points for procedural reasons, resulting in a decrease of the refinancing rate and consequently, a drop in tracker rates.