Mortgage holders may well be nervous reading the headlines. Senior figures in the International Monetary Fund (IMF) and the European Central Bank (ECB) are trying to dampen hopes of early interest rate cuts.
The chaos in the Red Sea is pushing up inflation. The latest figures show Irish – and euro zone – inflation going up a bit, adding to nervousness about when interest rates might fall.
Borrowers need to keep the faith. Unless there is some unexpected upheaval, interest rates are falling this year. Consider how far the ECB rhetoric has changed – late last year its council members were cautioning that interest rates could increase further.
Now they are suggesting that market expectations that interest rates could start falling during the spring are wrong, but tacitly accepting that this is likely to happen during the summer.
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Whether interest rates might fall in April or June may matter if you are running a big investment fund – and will definitely do so if you are a hedge fund placing bets on minute price changes. But if you have a 25-year mortgage, the difference is marginal.
Of course some tracker mortgage holders are financially stressed and the sooner the downward move starts the better. But interest rates will go down in small increments – what matters most is how significantly and quickly they will decline, rather than when the first cut comes.
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The statistical decline in inflation may be bumpy – partly because of the ups and downs seen in the early 2023 figures from which annual rates will be calculated over the coming months. But price pressures are clearly easing and consumers are starting to benefit, as shown by the cuts in gas and electricity bills announced this week and the drop in price of some household staples.
Euro zone inflation ticked up to 2.9 per cent in December from 2.4 per cent in November, but the general trend is now clearly downwards. The latest survey by Indeed, the jobs site and the Central Bank of Ireland shows wage growth in the euro zone slowing to 3.8 per cent in December, with more than half job categories showing growth slower than in June. This is expected to continue to decline in 2024, the report says, which will be a vital factor for the ECB, which worries that wage growth will slow the overall decline in inflation.
There are always dangers, of course. The disruption to trade in the Red Sea underlines the risk of the Gaza conflict spreading more widely in the Middle East, a key energy producer.
So far analysts believe the impact on inflation will not be too significant, but this will all depend on how things develop. But on the other side of the equation it is also possible that inflation could fall more quickly from here than expected, particularly looking at the weak economic performance in much of the euro zone and sluggish consumer demand.
And, as economist Simon Barry has pointed out, even if interest rates are cut, they will remain for a time high enough to generally have a restrictive impact on borrowing and the economy – in other words, central banks can cut a good bit while still bearing down on inflation.
As of now, investors are betting that the first ECB cut will be April and that by the end of the year rates will be 1.5 percentage points lower.
An ECB survey this week showed household expectations of inflation falling.It showed the median household expected prices to grow by 3.2 per cent in the following 12 months, down from 4.0 per cent a month earlier. Expectations for inflation three years ahead also came down to 2.2 per cent from 2.5 per cent.
This is important as the expected level of inflation feeds into wage demands – and also into what consumers will accept when they pay for goods and services. Inflationary expectations, the theory goes, trigger the real thing.
There is still room for market swings in the early months of the year. As of now, investors are betting that the first ECB cut will be April and that by the end of the year rates will be 1.5 percentage points lower.
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The ECB and IMF at Davos have been pushing back, with the bank’s president Christine Lagarde saying it would not even have the data required to make a decision until late spring and IMF first deputy managing director Gita Gopinath warning that central banks need to move cautiously to ensure that inflation does not make an early comeback. A concern of the authorities is that lower market interest rates are undoing some of the tightening of conditions from higher official rates, thus damaging the fight against inflation.
This PR offensive is having some impact on market prices and has influenced the expectations of economists. A survey by Reuters of 85 European economists undertaken over the past week showed an average expectation that interest rates would be one percentage point lower by the end of the year – a half point less of a cut than investors have priced in.
Opinion remains divided on when the first cut will come, with the largest number – 38 of the 85 – opting for June with 21 going for April and 23 opting for the third quarter or later.
Where does this leave mortgage borrowers, particularly first-time buyers? They are clearly facing significantly higher costs than those who bought during the long period when ECB rates were around zero.
The better news is that ECB interest rates have now peaked and offers to new mortgage holders should not increase any further, bar some market set back. And there is a decent chance that some offers will improve as the year goes on.
The next wave of borrowers will not be able to lock in at the rates of around 2.75 per cent which were available for many years and 3.5 per cent plus looks a more likely floor for most three to five year offers over the next couple of years.
The vast majority of new borrowers opt for fixed rate offers, according to mortgage broker Michael Dowling, favouring certainty on repayments in the early years of the loan. And there is still some decent offers in the market, for example, says Dowling, the green rates available for those buying a house with a BER Cert of A1-B3, which would take in most new home buyers.
There are also some rates that – in the context of a likely fall in interest rates – look on the expensive side. Borrowers also need to assess the varying level of flexibility which different lenders offer with fixed rate products in areas such as increasing repayments for a period or paying off part of the loan balance.
AIB, Haven, EBS and Bank of Ireland all offer three to five-year “green” rates under 4 per cent for those borrowing 80-90 per cent of the house value. Non-green fixed rate mortgages – which are likely to apply to most first-time buyers purchasing a second-hand property – start at just above 4 per cent, with Avant offering rates in the 4.05-4.1 per cent region.
Other three- and five-year fixed rates, however, are typically around the 4.75 per cent region. Some lenders offer lower rates on larger loans.
As banks have typically increased fixed rates by two percentage points or less – compared to the ECB’s four point increase, it may be some time before a general decline in these rates occurs. Competitive forces will hopefully lead to some of the higher rates being trimmed as the year goes on.
Non-bank lender MoCo, owned by Bawag Bank in Australia, launched in the Irish market last November and announced today that it was trimming its fixed rate offers here. Trevor Grant, chairman of the Irish Association of Mortgage Advisers, says he hoped that smaller lenders might announce cuts this year, even if the bigger players were slower to follow.
And in the longer-term much depends on where ECB rates might settle. But the next wave of borrowers will not be able to lock in at the rates of around 2.75 per cent which were available for many years and 3.5 per cent plus looks a more likely floor for most three- to five-year offers over the next couple of years.
Should first-time buyers opt for variable rates and hope that fixed rate offers come down? These variable rates are not particularly attractive at the moment in many cases – and may not fall alongside ECB rates. Indeed Permanent TSB has recently edged up its rate. AIB, Haven and EBS offer a reasonably-priced variable rate of 4.1 per cent, though others are typically in the 4.75 per cent region.
The unfortunate fact is that loans are priced so that most of the risk remains with the borrower. In the case of fixed rates, the risk now is of locking in for a long period at the top of the cycle.
As individual circumstances differ, professional advice from a broker is best before making the call – and it is certainly worth shopping around as there is a significant different in repayments between locking in for a fixed-rate loan at 4 per cent and one at 4.75 per cent.
As Dowling said, it is also worth considering locking in for a shorter period – perhaps three years instead of five – given the general downward trend in rates expected over the next couple of years. In some cases going variable for a short period might also be an option, but most are likely to want to lock in at some stage.
The unfortunate fact is that loans are priced so that most of the risk remains with the borrower. In the case of fixed rates, the risk now is of locking in for a long period at the top of the cycle.
There is no way to avoid this risk completely. But there is now clear competition in the market and a realistic hope that this will continue to deliver improving value as the year goes on. And a clear incentive to trawl the market for the best offer for your particular circumstances.
