Yesterday's rise of half a percentage point in euro zone interest rates will be welcomed by those concerned about the danger of overheating in the economy. The European Central Bank increased its main interest rate to 4.25 per cent; the resulting increase in bank and building society rates should help dampen consumer demand and act as a brake on the housing market. Mortgage rates are now likely to rise to around 5.4 per cent which will mean substantially higher repayments, imposing a particularly large burden on newer borrowers who took on larger mortgages. The clear message that there may be more increases to come should act as a deterrent to those thinking of taking on more debt than they can afford.
While higher interest rates may eventually help to slow the economy and dampen inflationary pressures, one immediate effect will be to push up the consumer price index further. This is because mortgage borrowing costs are counted as part of the CPI. This will be unwelcome news for the Minister for Finance, Mr McCreevy, who is already coming under pressure from a variety of institutions to curb inflationary pressures. Inflation in April was running at 4.9 per cent - almost double the European average. Petrol price increases in May and mortgage rate increases this month could mean that in June or July the rate will rise above five per cent.
In an interview in The Irish Times today the ECB president, Mr Wim Duisenberg, indicates that he has expressed concerns about inflationary pressures in the Irish economy to Mr McCreevy. The meetings between the central bankers and the €11 finance ministers are confidential. But Mr Duisenberg clearly expressed his concern about what he called a "vicious circle" of rising prices driving higher wage demands which in turn, fuel inflation. The concern expressed by Europe's most senior central banker contrasts with the Government's approach which, until now, has been relaxed almost to the point of complacency. Referring to the recent rise in asset prices in the Republic as "extraordinary", Mr Duisenberg predicted that, as it becomes ever more difficult to buy a home, the Irish public will put pressure on its leaders to take action.
The planned introduction of a second Finance Bill later this year represents a unique opportunity to tackle the housing crisis and to help bring inflation down towards the European average. The Government must increase the supply of housing and the land available for building - much of which is now being drip-fed into the market. It must also devise measures that will make it easier for first-time home buyers to enter the market. Other measures, such as some reductions in indirect taxes, may also now need to be considered, particularly if they help to ease pressure on wage, as the other key task for the Government is to resist many of the pay demands now emerging in the public sector. In the months ahead the Government will be called on to put a continued focus on these issue. As Mr Duisenberg points out if the present trend of rising asset and consumer prices feeding into wages continues, Irish industry will "compete itself out of the market" and long-term growth and employment prospects will suffer.