With interest rates likely to be increased shortly by the European Central Bank, the weekend reduction in its variable mortgage rate by the Bank of Scotland came as a surprise. The bank already triggered a round of interest rate reductions when it entered the market here over the summer. Now it has reduced its rate from 3.99 per cent to 3.69 per cent, leaving it as the cheapest in the market. For the moment, at least, the main Irish lenders are not likely to respond. The Bank of Scotland shook up the mortgage market when it first entered in August. The main lenders here had been tardy, to say the least, in passing on to borrowers the interest rate reduction associated with the entry to the euro zone. The injection of competition into the market meant that they had to respond. The resulting reductions in mortgage rates meant a significant saving for borrowers. It was probably not what the economy needed, given the strong rate of growth and the rapid rise in house prices. But following the advent of the euro it was only a matter of time before extra competition entered the financial market here. The domestic institutions left themselves open to attack by trying to maintain fat profit margins in the early months of the year.
The precise motivation for the latest move by the Bank of Scotland is unclear. The bank has not revealed the exact level of business which it has attracted in the Republic; it has said it has approved mortgage advances of £200 million but it remains unclear how much of this money will actually be drawn down. Whatever its success to date, by reducing its variable rate further the Bank of Scotland is upping the ante in trying to attract business for the existing lenders. Its move comes as euro zone interest rates look set to start a gradual rise. The initial increase will probably be modest - of the order of 0.25 to 0.5 of a percentage point - and will have a limited impact on the costs to borrowers. But the imminent rate rise - whether it comes in the weeks ahead or early in 2000 - will be the first move in a gradual raising of rates. Those taking out loans would do well to calculate whether they could afford repayments if interest rates rise by a couple of percentage points over the next year to 18 months. Growth in the main euro zone economies is recovering and this is why the European central bank is set to increase interest rates. Borrowers here will hope that rate increases in the months ahead will be modest and that the European Central Bank will not feel the need to announce sharp rises to clamp down on inflation. A modest increase in interest rates could help to cool the housing market here, but a sharper rise could leave many borrowers facing difficulties. Greater competition in the mortgage market will also hasten restructuring in the financial sector. Already First Active is contemplating cutbacks and some other institutions may do likewise. The number of players in the market looks set to be reduced in the years ahead by acquisitions and mergers.
For the moment, however, the fight is on for the business of borrowers. As attractive offers are put into the market, those taking our loans should remember that the trend in interest rates will be upwards for the next couple of years. And there is a responsibility on lenders not to advance excessive amounts to borrowers, as by so doing they would store up trouble for both their customers and for their own balance sheets.