Interest rates are on the way up again. The latest 0.25 of a percentage point increase in European Central Bank (ECB) base interest rates will quickly knock on to higher costs to borrowers. Savers, meanwhile, should benefit, particularly those who are prepared to leave their money on deposit for reasonably lengthy periods. Further increases in interest rates look certain later this year; the timing and extent of the rises, however, remains uncertain. The ECB has now increased interest rates by a full percentage point since last November, with its base rate up from 2.5 per cent to 3.5 per cent. This is in response to a recovery in economic growth in the main euro zone economies and the resulting pick-up in inflation.
Market analysts had been divided on whether the ECB would increase interest rates at yesterday's meeting. It appears that the bank's governing council was prompted to move by the inflationary threat posed by rising oil prices and the weakness of the euro. Further increases are likely to bring euro base rates at least another 0.5 of a percentage point higher to 4 per cent by the end of this year. Much will depend on the trend in oil prices, due to be discussed by OPEC ministers late this month.
In determining interest rate policy, the ECB must consider the overall performance of the euro zone economy. In these terms its policy of pushing up interest rates gradually is understandable. However its difficulty is that the performances of the different euro zone economies vary considerably. Economies such as Ireland and Spain are growing rapidly, while recovery is only now setting in for bigger economies such as Germany and France.
Irish policymakers, in particular, will welcome the latest interest rate rise and the prospect of more to come, hoping that the trend will take some steam out of the housing market. Those thinking of taking on new loans - and the financial institutions lending out money - must take into account the impact of further rate increases on repayments in the months ahead. The trend in borrowing costs will be upwards for at least the next eighteen months.
Fortunately for borrowers - and for savers - tough competition in the lending and savings markets should ensure that financial institutions do not profit unduly on the latest trend. Rates for borrowers are likely to rise in step with the increase announced by the ECB. Some institutions have already increased rates by around 0.25 of a point in response to the last ECB increase and will now move by the same amount again, while others who have not yet responded to the previous ECB rise will push rates up by 0.5 of a point.
Savings rates, meanwhile, should also increase and depositors would be advised to compare rates between different institutions and to consider the extra returns available to those who are prepared to leave their money untouched for six months or more.
The cumulative impact of the recent interest rate increases may, however, do little to slow the overall growth of the economy. In real terms - compared to inflation - borrowing costs here remain relatively low and exporters continue to benefit from the weakness of the euro. Higher rates - and the threat of more to come - may put a modest brake on the housing market, but will do little to slow the economy in general.