This year started with an expectation that interest rates would stay steady, or perhaps even edge lower. Three months on, everything has changed. Financial markets are anticipating some moves upwards by the European Central Bank (ECB) – though the outlook remains uncertain. One non-bank lender, ICS Mortgages, has already increased its borrowing rates. So how should borrowers and potential borrowers react?
Recognise the uncertainty
Those in the mortgage market – on variable rates, looking for a loan or coming off a fixed rate – have no option but to accept the uncertainty. And to realise that nobody knows what is going to happen. Financial markets are “pricing in”, or anticipating, two to three quarter-point ECB interest rate hikes this year. But these markets can change quickly, driven by events. In an environment where oil prices might be $100 in the morning and near $120 by lunchtime, nothing is certain.
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We might look at three scenarios, just to illustrate this. The first is that Brent crude prices remain around the $100 mark, roughly Thursday morning’s level – and gas prices also remain high. And that they only gradually fall back in the months ahead. This would give an upward boost to inflation and the ECB might increase interest rates as a result. Investment bank Nomura believes that if this were the level of oil prices, then the ECB would raise rates by a quarter point in both June and September.
In a speech this week, ECB president Christine Lagarde said it would take time to “assess the nature, size and persistence” of the inflationary threat, but the ECB stood ready to react in a graduated way. The ECB cannot influence energy inflation directly so it is trying to deal with the wider impact. It will also realise that the crisis will hit economic growth and so it has a tough balance to strike.
Some market analysts believe a rise at the next meeting late in April is possible, depending on events. By then, March inflation figures will show a rise – Conall Mac Coille, chief economist at Bank of Ireland, has predicted Irish inflation will rise from 2.7 per cent in February to between 3.5 and 4 per cent in March, and the ESRI and Central Bank have also issued inflation warnings.
The second scenario is that the conflict worsens, oil goes to, say, $150 a barrel, there is wider transport disruption and further damage to production infrastructure. And thus a larger threat to inflation. In this scenario three ECB rises, totalling 0.75 points of a rise, could be possible, with more heading into 2027.
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Lagarde said drastic action would only be needed if inflation diverged “significantly and persistently” from the ECB’s 2 per cent target. Energy prices at these kind of levels would open up that kind of threat, but only if they persisted. This is not what the market expects now, though who knows?
The third is a relatively quick resolution of the conflict in which wholesale oil and gas prices fall back quickly. If this happens, an ECB rise might be avoided, or limited. Having been criticised for not moving quickly enough after the Ukraine invasion, the ECB might shoot first and ack questions later this time. Some inflation has already been embedded in the system. But the euro zone economy is not under the kind of pressure it was post Covid, when the fallout of the Russian invasion hit.
Broker John Fahy of Pangea says the conflict could be resolved by the time the ECB governing council next meets at the end of April and although there would still be a temporary boost to inflation, it would quickly work through. He is hopeful the outlook for interest rates may thus remain relatively stable, even if some non-bank lenders such as ICS, relying on wholesale markets for funding, are forced to move rates up.
Calculate the odds
The difference in these scenarios is wide, but let’s look at the different types of mortgage holders. Those on tracker rates will see repayments vary with the market and thus they may increase. Some locked into fixed rates during the 2022 rise in interest rates. Anyone contemplating this route now should move quickly as current fixed rate offers could start to edge upwards. A typical tracker rate still stands at a relatively attractive rate of under 3.5 per cent – so a series of ECB rises would be needed to make them look costly compared with today’s fixed rates. As we have seen, it is not clear what extent of interest rate increases we will see, but there may well be some.
Those taking out new mortgages still have some attractive offers and they need to carefully consider first where the cheapest loans are available for their circumstances, including size of loan, deposit available and Ber rating in particular. And then how long to lock in for. Anything in the 3-3.5 per cent range – the better rates in the market – looks increasingly attractive against a backdrop of possible ECB base rate rises.
A point to note is the rates of some non-bank lenders now look uncompetitive, due to their reliance on the market to raise funding. ICS Mortgages increased its 3 and 5 year fixed rates by between 0.35 and 0.5 of a point this week, taking them over 4.75 per cent.
A similar calculation applies to those rolling off fixed rates. Those who can now lock on again should do so without delay. The concern now would be that those who are due to do so in, say, six month, would face less attractive options. They would be well advised to take professional advice on all their options, including switching.
The bottom line
Competition had led to gradual improvement in some mortgage offers in recent months and a broadly stable market. Now, however, the funding squeeze on non-bank lenders will reduce competition a bit, though a new owner for PTSB could soon be a factor. Any ECB rises would put the wider market under upward pressure. Against this backdrop, mortgage borrowers need to do their homework, take professional advice and seriously consider any decent offer to lock in at the more attractive current rates if they can.