In June, the decision by the European Central Bank (ECB) to reduce interest rates sparked optimism that there could be further cuts down the track – although not necessarily imminently. However, recent weeks have seen an air of cautiousness infiltrate the outlook due to an array of political and economic influences. Therefore, the question is raised: what can loan holders potentially foresee, and is there a risk that future planned deductions may not transpire, or if they do, that there could be a longer waiting time than initially predicted?
To give context, the ECB launched a strategy to decrease inflation from the extraordinary levels seen during the cost-of-living crisis, resulting in reaching unprecedentedly low interest rates. This approach seems to be effective, especially in combination with global patterns, as energy prices have significantly receded from the highs experienced after Russia’s assault on Ukraine. The inflation rate within the euro zone, which escalated to a peak of 10.6% in October 2022, had decreased to 2.5% by June with the ECB aiming for a gradual progression to the target of 2% by the end of next year. Their projections anticipate an inflation average of 2.5% this year and 2.2% the following year. Though seemingly positive, there are uncertainties that persist.
The decrease in inflation rate has been substantial and rapid. However, a more prudent faction within not only the ECB but also the US Central Bank (Fed), express concerns about ‘the last mile’ – essentially reducing the current inflation rate to the precise target of 2%. The International Monetary Fund also foresees potential challenges in achieving this, due to possible entrenched inflationary pressures like those appearing in the job market and the services sector, which could be hard to regulate and may risk keep inflation higher than desired.
According to Simon Barry, an economist, some of the newly acquired data hasn’t matched the ECB’s favourable expectations. As he explains, the recent figures for consumer prices throughout June confirm a core price inflation (excluding food and energy) that is exceeding expectations as we enter the second half of the year. Services price inflation remains especially rigid, exceeding 4%. Thus, Barry suggests that it may take the ECB longer to collate sufficient data to ascertain whether their expectations for inflation to revert to target levels by the end of the next year (and maintain) is plausible.
Reports have surfaced indicating that high-ranking ECB sources are expressing concerns about the potential effects of the fluctuating geopolitical environment on 2024. One issue raised is the recent French democratic exercises, with growing anxieties that a more left-leaning administration may not take significant steps to reduce the budget deficit. Additionally, fears persist that a populist agenda, featuring expansions that could foster inflation, may be a part of any new government’s plan. Other latent risks include the prospective of tariffs and a trade war following a Trump administration.
In politics, risks are to be expected. It’s noteworthy, however, that such elements could influence growth and inflation alike, creating a complex dynamic through which to perceive potential implications for interest rates.
The Prognosis
The current uncertainties render the future somewhat precarious and fraught with a higher level of uncertainty. Yet, at this juncture, another ECB reduction, likely around a quarter point, is projected for the first council meeting in September after the summer hiatus. A recent study by the German entity ZEW, surveying roughly 350 German-based analysts posits that interest rates will most likely follow a gradual decrease. However, the rate and extent at which borrowing costs would decrease remain uncertain.
In light of this ambiguity, it’s expected that the ECB will follow an amalgamation of official data (some available quarterly) and revised estimates from its own personnel, available tri-monthly. Barry suggests that this aligns closely with market interest rate forecasts, with markets preparing for two additional adjustments this year, in September and December. These coincide with the release of new ECB staff projections. The ZEW survey indicates that 68% of economists foresee a drop in September. A larger 73% predict a descendant shift in December, while merely 24% predict a decrease in the intervening October meeting.
Assuming these are correct and the reductions are a quarter point each, the ECB deposit rate would decrease to 3.25% by the close of this year with room for further cuts, bringing the deposit rate down to or slightly below 3% in 2025.
Naturally, such predictions can never be perfect, with market expectations subject to rapid changes. The best course of action for borrowers is to act in accordance with present data and probable future trends.
The implications for borrowers?
The shifting dynamics in the realm of interest rates have elicited an air of vigilance, underpinning the potential of a slower-than-anticipated drop in rates. Observably, the ECB council is polarised on the most suitable rate reduction rhythm, thereby raising the significance of data as a determining factor which could influence decisions one way or another.
Presently, the consensus is that we’ll witness two additional cuts this year, likely a quarter-point each, coupled with some additional reductions in 2025. The prevailing interest rate level is notably high, as Simon Barry indicates, suggesting that further reductions should not cause unease as they will still serve as an inflation dampener for the ECB. There is an ongoing discussion regarding the ‘neutral’ interest rate, or the rate that neither spurs nor curtails economic growth and inflation. But on any reckoning, it likely corresponds to a deposit rate in the 2 to 2.5 per cent range, signalling considerable scope for further reductions.
Every rate reduction effected by the ECB has direct implications for tracker mortgage holders. Primarily, it’s important to note that due to an impending technical amendment in ECB interest rates, the majority of mortgage holders are set to benefit from a quarter-point ‘bonus’ cut in the autumn. The central bank plans to narrow the difference between its current deposit rate (3.75 per cent) and the so-called refinancing rate (4.25 per cent). The refinancing rate is the benchmark for pricing tracker mortgages, which means repayments will become marginally less burdensome as this gap shrinks to a quarter-point.
Assuming current market predictions hold true and the deposit rate diminishes twice more following the initial decrease in 2024, tracker rates, including the bonus, could dip by a whole percentage point in 2024. However, given that they increased by 4.5 points, this simply mitigates some of the previous surges. Some additional drops are expected to occur next year, but it’s unlikely that tracker rates will revert to historical lows.
Recently, those entering the housing market, relocating, or at the end of their current fixed-term agreement have typically chosen fixed-rate products. Nevertheless, this year has seen a surge in variable rate preference in the hopes of better deals. Numerous clients have been rewarded as competitive sparks were ignited around March coupled with the first ECB cut, resulting in a chain reaction of reductions for customers.
The landscape of interest rates remains varied, and despite potential decreases in market interest rates, some appear to remain comparatively high, implying that vigilance is essential. For example, interest rates marketed as “green”, or those accessible to houses with higher BER ratings, seem appealing, sitting mainly in the 3.5 to 3.75 per cent range. Contrastingly, non-green loans’ interest rates in certain situations can increase from 4.5 per cent and exceed 5 per cent. This seems steep as smaller lenders such as Avant, are now offering fixed rates commonly less than 4 per cent.
The variable factors in loan applications and their respective costs are copious. Therefore, it is suggested to compare offers and seek expert advice from an independent broker, which most of the times may not incur any charges. It’s pivotal to acknowledge that following the initial flurry of competition, the steady decline of ECB rates and their associated ambiguity implies a gradual reduction in the fixed rate offers and ordinary variable rates.
Competitive pressure might lead to reductions in some high-interest rates, whereas the rates of around 3.5 to 4 per cent might not decrease further for the time being. If the ECB reduces again in September along with anticipation of a further reduction in December, it may result in another round of widespread reductions. While rates may have escalated rapidly, declines are projected to take a gradual course.