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Rate Rise Will Hurt 50,000

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http://www.thepost.ie/post/pages/p/story.a...2027-qqqx=1.asp

Rate rises could put squeeze on up to 50,000

26 February 2006 By Austin Hughes

Don’t say you weren’t warned. The cost of borrowing is set to rise again very soon, according to a range of senior European Central Bank (ECB) officials in the past week. Their comments were clearly intended to prepare the way for a rate rise at the ECB’s next policy meeting which takes place on Thursday.

All the indications are that like last December’s move, the increase will be a quarter of a percentage point. On the face of it, Irish borrowers don’t seem to be too concerned about the prospect of higher interest rates. December saw the largest ever monthly rise in bank lending, fuelled by the biggest monthly rise in mortgage lending on record.

In addition, consumer sentiment improved in December and January as households became more upbeat about general economic prospects, their own financial situation and the general buying climate. So as a nation we seem more than happy to carry on borrowing.

Why are higher rates not hurting? There are several reasons.

One is that rates are still abnormally low by historic standards and borrowing costs aren’t expected to rise too far or too fast - gone are the days when central banks took a sadistic delight in ‘‘shocking’’ us with unexpected rate increases.

So today’s borrowers feel comfortable that they will not suffer any nasty surprises in relation to their monthly repayments.

Unfortunately, the reduced risk of unexpected increases in monthly loan repayments owes something to the fact that even nastier surprises such as last week’s job losses at NEC in Co Meath seem likely to remain commonplace. The growing influence of Asian countries producing low cost goods means that inflation is set to remain fairly low worldwide.

As a result central banks, whose job it is to control inflation, don’t have to raise interest rates as aggressively as in the past. Cheap labour has been a key driver of cheap money in recent years and looks set to remain a powerful influence on borrowing costs. That said, while money should remain fairly cheap, this doesn’t mean it will always be as cheap as it is today. There may be too much complacency about how many rate increases we will see in the next 12 to 18 months.

To judge from financial markets earlier this week, it appears that a rate rise on Thursday is universally expected.

A further increase is anticipated before the end of the summer and opinions seem divided as to whether the ECB will raise rates yet again later in 2006.

I think it is likely that the ECB will raise rates to 3 per cent and a slightly higher rate can’t be entirely ruled out before the end of the year. For a huge number of Irish borrowers, adding another percentage point to loan rates could make a big difference to their financial situation.

Although last December’s rate rise seems to have barely caused a ripple, the prospect of a sequence of increases stretching far into the future might be altogether more troublesome.

Before the ECB’s most recent move, Irish borrowers hadn’t experienced a rate hike since October 2001.

Since that date, more than 425,000 mortgages have been taken out, prompting a €60 billion increase in mortgage lending.

In the light of these numbers, it doesn’t seem unreasonable to suggest that an entire generation of Irish borrowers may have no experience of handling rising monthly repayments.

The vast majority of borrowers should not have too many difficulties. Budget largesse from Minister Cowen, the looming maturity of SSIAs and rapid increases in the numbers living and working in this country also mean that borrowing growth and the Irish housing market will remain very strong in coming years.

However, a not insignificant number of Irish borrowers, particularly those with relatively new and large mortgages, may find life less comfortable.

Last year’s IIB/ESRI study ‘Consumers and Debt: Are they worried? Should we be?’ suggested that around one in seven Irish borrowers found their debts imposed a heavy burden on their household finances.

In many instances, these concerns probably reflect the cumulative impact of mortgage debt, lifestyle borrowings, childcare costs and other significant outgoings on household budgets.

The same survey also found that Irish borrowers were notably more cautious than their British counterparts in spite of the fact that British debt levels and borrowing costs are higher than in Ireland. In part, such concerns reflect the fact that high debt levels are a very recent development for most Irish borrowers.

Drawing on these results, I would tentatively estimate that up to 50,000 Irish borrowers could face a significant squeeze on their spending power if the ECB moves its key interest rate above 3 per cent this year.

If they are not SSIA holders, a significant number of these will find their personal experience of the next year or two very much at odds with the popular depiction of a generation enjoying a ‘‘you’ve never had it so good’’ consumer boom.

Because the likely scale of ECB interest rate increases will be modest and the speed at which rates rise shouldn’t be too threatening, it would be wrong to exaggerate the risks to most borrowers or to the Irish economy as a whole from the looming rise in interest rates.

The advent of SSIAs and surging immigration should ensure activity and spending will remain very healthy for the next couple of years.

That said, the recent rapid rise in debt levels means the Irish economy is now far more sensitive to interest rate changes than before.

This may be no bad thing: with Minister Cowen likely to deliver another generous budget in December and the bulk of SSIA spending likely to hit the economy 2007, the offsetting impact of higher borrowing costs may come at a particularly fortuitous time.

However, for a small minority of borrowers who haven’t budgeted properly for larger monthly repayments, that will be of little comfort.

Austin Hughes is chief economist with IIB Bank.

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  • 302 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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