The ECB meet in Frankfurt today. It is Christine Lagarde’s second meeting as President of the ECB having taken over from Mario Draghi last October.
We are unlikely to see a change in monetary policy today. The minutes of the ECB’s December meeting – released last week – reiterated the need for a “highly accommodative monetary policy stance for a prolonged period of time.” The upshot of this? Interest rates are likely to remain at historic lows in a bid to boost prices towards the ECB’s inflation target of close to 2 percent over the medium term.
The refinancing rate, the rate at which the ECB lends to banks, will remain at 0 percent. Banks will continue to have to pay to deposit reserves at the ECB - earning a negative interest rate of 0.5 percent.
Lower interest rates should reduce the cost of borrowing for a broad range of loans from consumer loans to mortgage loans and so boost consumption and investment. This, in turn, should boost inflation.
The ECB restarted its quantitative easing (QE ) programme with a €20 billion bond purchase in November. QE works through many channels and increased lending is one of them. The idea here is that the ECB buys bonds from banks and financial institutions and banks then lend out a proportion of the funds they receive. In a statement last week, the ECB expressed approval of how this was working.
What about Ireland? Are Irish banks passing on low interest rates to the economy?
The Central Bank of Ireland released figures on 10th January that show that the weighted average interest rate on all new mortgages agreed in Ireland stood at 2.90 per cent in November 2019, down 0.11 percent since the beginning of 2019. The average rate for the euro area was unchanged at 1.37 percent. Although mortgage interest rates are historically low by Irish standards, we are continuing to pay double what our European counterparts are paying.
This interest rate differential extends to consumer loans too. New loan agreements for consumer lending had an average interest rate of 8.04 per cent in Ireland over the same period. The equivalent euro area rate stood at 5.51 per cent.
This is likely due to the lack of competition in Irish banking with the Bank of Ireland and AIB making up approximately 60 percent of the Irish mortgage market.
However, Irish banks have passed on low deposit interest rates to their customers. Interest rates on new household term deposits remained close to zero in November, at 0.04 per cent. The equivalent euro area rate stood at 0.29 per cent.
Sinn Fein has pledged to make this an election issue. They promise to introduce new legislation to allow the Central Bank to cap the interest rates at which banks lend to us.
This is not the first time that this has become political.
In 2016, a bill was proposed by Fianna Fáil that would give the Central Bank powers to cap variable mortgage rates but it wasn’t progressed as the Attorney General advised it could be unconstitutional.
Nor does the Central Bank want these powers. They argued against the bill at the time indicating that interest rates were relatively high in Ireland because banks had to take on more risk as the rate of mortgage default was high compared to the rest of Europe. In addition, the relative rate of repossession is low. The low-level of repossessions makes it uncertain for banks as to how easily they can get their money back from borrowers in the event of default and makes lending more risky.
The Competition and Consumer Protection Commission also argued against the bill suggesting it would lead to banks only lending to very low risk borrowers and would deter new entrants into the market reducing potential new competition in the sector.
Therefore, the status quo is unlikely to change. The only thing that would drive down interest rates towards European rates is more competition in the Irish market.
The ECB are also likely to discuss the scale and scope of a strategic review of how the ECB does its business today. This is a broad sweeping review which will range from how appropriate their core objective of price stability is to how the ECB should play its part in tacking climate change. This review could take up to a year to complete and the outcome is uncertain. However, one thing is certain. Interest rates are not moving up any time soon. Good news for borrowers, bad news for savers.
Marie Finnegan lectures in economics in GMIT and is Programme Director of the Bachelor of Business (BBS ) in Finance and Economics. For more see https://www.gmit.ie/business/bachelor-business-honours-finance-economics
