Q&A: What would ECB interest rate hikes mean for you and your mortgage?

Since earlier this year, the European Central Bank (ECB) has been signalling a tougher anti-inflation stance and an end to more than a decade of ultra-loose monetary policy.

To combat the fallout from the 2008 financial crisis and the Covid-19 pandemic, central banks have been pumping literally trillions of euro into the global financial system while keeping interest rates on the floor in a bid to bolster flagging growth.

That’s all about the change. Now the enemy is inflation, which is currently running at a record 8.1 per cent across the euro area and at a 38-year high of 7.8 per cent in the Republic.

To counteract this, the ECB signalled on Thursday it would begin raising rates from next month – making it more expensive to borrow – while discontinuing its asset-purchasing programme.

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How much will rates go up by?

Following a meeting of the ECB’s governing council in Amsterdam, the bank said it would raise its key lending rate by 0.25 percentage points from July 21st, the date of its next meeting, while ending its long-running bond-buying scheme from July 1st. This will be the first upward shift in rates in 11 years. It represents a sea-change in monetary policy.

The rise will lift the ECB’s main deposit rate for commercial banks from -0.5 per cent and increase the ECB refinancing rate from 0 per cent. Perhaps surprisingly, the ECB also said it would move rates up again in September, and possibly by a bigger margin. Ahead of the meeting, central bank governors in several euro area countries floated the idea that the ECB may adopt a more hawkish stance by announcing a 0.5 per cent hike.

This may have been mere shadow boxing to ensure the ECB, the least reactive of all the major central banks, moved decisively. “If the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting,” the council said. Markets expect even more aggressive action, pricing in 135 basis points of hikes by the end of this year, or an increase at every meeting from July, with some of the moves in excess of 25 basis points.

[ Mortgage hikes to come as ECB announces interest rate increase ]

Will it halt rocketing prices?

That’s a difficult question to answer given the uncertainty around energy prices generally and the fallout from Russia’s war in Ukraine. Some also argue that because the euro area is a net importer of energy, the current surge in inflation is effectively imported inflation – in other words, inflation over which monetary policy has little control.

Nonetheless, with inflation at over 8 per cent, four times the ECB’s target rate of 2 per cent, the bank’s hand has been forced. ECB chief economist Philip Lane is on record as saying, however, that it would take a big shift in the inflation outlook to warrant a 50-basis-point hike, which some more hawkish members of the council are pushing for.

The fear is that increasing interest rates too fast risks triggering an economic slowdown or even recession instead of just taking the heat out of price increases. Many fear the euro zone is already headed for recession on the back of war in Ukraine.

As Robin Brooks, chief economist at the Institute for International Finance in the US, put it in a tweet: “The euro zone is going into recession. Inflation is yesterday’s worry.” Raising interest rates will in theory limit price growth but increased borrowing costs will hinder growth. It’s a delicate balancing act.

How will the interest rate hikes affect consumers here?

Those on tracker mortgages or variable mortgage will see an almost instant increase in their monthly repayment as lenders pass on the increase in rates. “For someone with €200,000 remaining on their tracker mortgage over 20 years – currently paying a margin of 1 per cent – they’re looking at an increase in repayments of around €45 a month from a 0.5 per cent hike,” head of communications at price comparison website Bonkers Daragh Cassidy said.

“If you’re an average first-time buyer borrowing €250,000 over 30 years at the average rate of 2.78 per cent, a 0.5 per cent increase would add around €70 a month to your repayments if you’re on a variable rate,” he said.

While these sums are not huge, Mr Cassidy warned that if ECB rates were to eventually return to more normal levels – 3 per cent, for example – a €250,000 mortgage would be over €400 more expensive each month while a €500,000 mortgage would be €800 extra per month. This is based on the average rate in Ireland going from 2.78 per cent at present to 5.78 per cent.

This, combined with higher prices generally, has the potential to trigger a major cost-of-living shock. With higher interest rates on the horizon for the short to medium term, many financial experts are now advising would-be home purchasers to opt for fixed-rate contracts.