Irish depositors face paying the price for ECB’s lonely rates stance

European Central Bank (ECB) president Christine Lagarde and her Irish chief economist, Philip Lane, cut increasingly lonely figures this week as influential central bankers elsewhere turned more hawkish on the prospect for interest rate hikes to contain the post-pandemic spectre of inflation. Irish depositors may ultimately be asked to pay the price.

The US Federal Reserve signalled on Wednesday that half of the 18 members of its monetary policy committee now expect to raise interest rates by the end of next year. And nearly all are pencilling in further hikes in 2023, as they become increasingly concerned that a recent spike in inflation could prove stickier than previously thought.

On this side of the Atlantic, the Bank of England warned on Thursday that the case for higher interest rates “appeared to have strengthened” as it predicted consumer price growth could temporarily hit 4 per cent this winter – double its target. Economists now expect a UK rate increase by February, with some even tipping a move by the end of this year as a possibility.

What of the ECB? Well, although euro-zone inflation is estimated to have hit a 10-year high of 3 per cent in August, well above the bank’s 2 per cent target, it sees this as temporary, driven by runaway energy costs. Its number crunchers estimate that consumer price growth will ease back to 1.7 per cent next year and 1.5 per cent in 2023, the end of its official forecast horizon.

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And while Lane is reported to have privately indicated earlier this month that inflation may hit 2 per cent in 2025, the consensus view in financial markets is that he won’t be preparing papers for an ECB governing council vote on upping rates until 2024. The ECB, for the record, has denied that Lane had made those remarks.

This includes the controversial negative rate of 0.5 per cent that the Frankfurt-based organisation currently charges banks across the euro zone for excess cash they deposit with it.

First mover

In 2014, the ECB was the first major central bank in the world to lower one of its key interest rates into negative territory, with the aim of encouraging banks to provide more credit to the economy and stimulate growth.

While it was followed by the central banks of Japan, Switzerland and Denmark, there has been much debate about whether negative rates do more harm than good to the financial system, eating into the profits of already weak European banks.

The sector is estimated to have paid the ECB about €34 billion in charges on excess liquidity deposited with it in the seven years to June, according to figures compiled by German fintech Deposit Solutions.

Although Irish banks were initially reticent about passing on the pain to their customers, they've been widening the net in recent times. At the start of this year, AIB was charging negative rates to many businesses with more than €3 million on deposits. The cut-off point at Bank of Ireland was €2.5 million. Both have moved to lower the threshold to €1 million and bring in personal account holders for the first time.

High net-worth individuals with at least that amount sitting in an AIB account can expect to be hearing from the bank within the next couple of weeks about how they will have to pay up for the luxury by the end of the year.

The volume of its deposits subject to negative rates will have almost quadrupled over the course of 2021 to €15 billion as a result, the bank estimates.

Bank of Ireland is also on track to have about €15 billion of customer savings – just under 17 per cent of total deposits – attracting negative rates by the end of 2021.

“We wrote to all business and personal customers earlier this year about a drop in the negative interest rate threshold where customers have an average of more than €1 million on deposit. Negative interest will apply to these balances from October,” a spokesman said.

Irish banks are bedevilled by the opposite problem to that they suffered from during the financial crisis, when the markets punished them severely for being over-reliant on wholesale funding and customer deposits were walking out the door. In recent years, they’ve had the burden of holding more cash than they know what to do with.

And this has only been exacerbated by Covid-19. The Department of Finance estimates that, of the €22 billion surge in household deposits during the pandemic, some €15 billion represents excess savings – above the trend at which people were saving before the crisis. While some of this is now being unwound as the economy continues to reopen, it will take time.

Deposits vs loans

Banks may also be increasingly optimistic about credit demand. But the combined deposit bases of AIB and Bank of Ireland exceeded the size of their loan books by €45 billion at the end of June.

While some of these will be put to use with the two lenders buying up large parts of Ulster Bank and KBC Bank Ireland as the overseas-owned lenders retreat from the market, there's also the small matter of Ulster Bank's almost €22 billion of deposits needing to find a new home.

"The longer the ECB pursues dovish policies, the greater pressure this exerts on banks to expand the base of deposits subject to negative rates," said Diarmaid Sheridan, an analyst with Davy, noting that the banking supervision side of the ECB "has been quite vocal on the need for banks to improve profitability and returns from current levels to become more sustainable and robust".

Permanent TSB, alone among the surviving banks in not passing on negative rates, may hold out for even longer. Although its deposits book is currently about €4 billion bigger than its amount on loan, it needs to lure some Ulster Bank savers to help fund its planned purchase €7.6 billion of mortgages from the exiting UK-owned lender.

But it’s surely only a matter of time before the other two look to cross the €1 million Rubicon?