When the European Central Bank governors met this week to announce that its main interest rate was to be cut to a record low of 0.5% nobody was surprised…but not everyone was particularly happy.
The rate cut was made against a backdrop of a falling Euro inflation rate currently standing at 1.2% (the ECB generally targets a 2% inflation figure) and persistently moribund economic and employment data.
The ECB meeting took place in Bratislava instead of the more usual Frankfurt. Unintentionally notwithstanding, its convening in a non-German venue perhaps symbolically underscored a subtle shift during Mario Draghi’s tenure away from the German worldview of how the euro crisis is tackled.
Although Bundesbank president Jens Weidmann reportedly voted for the cut, Chancellor Angela Merkel said that the ECB would have to raise rates if it was looking at Germany alone. Her inflation concerns means she does not greet this as good news at all and a consequent weakening of the euro spells danger for many in Frankfurt even if it is continued good news for soaraway German exporters.
Good news for the people of Ireland?
For people on tracker mortgages: Yes. This rate cut is undoubtedly good news for the 375,000 people who hold tracker mortgages in Irish banks. Even a quarter of a point of an interest rate cut means that a tracker mortgagee with a loan of €200,000 will save €24 per month or about €300 per year. With mortgage interest relief not factored, this ‘free money’ could effectively equate to a salary increase of €500 per annum at the marginal tax rate depending on one’s circumstances.
For people on variable rate mortgages: No. In more normal times’ past, the Irish banks would have usually passed on this interest rate cut to those on variable rate mortgages (fixed mortgage rates would not change by definition). However not only have the Irish banks signaled that they will not pass on the cut, they are more likely to increase the interest payments on variable mortgages in order to offset the widening losses they are currently incurring on tracker mortgages.
For deposit holders: This rate cut is not on the face of it good news for people with deposit accounts as it means their already meagre returns (if not effective losses) are likely to be reduced overall by .25%. The banks however (unlike with tracker mortgages) do have a choice in whether to apply this cut to all deposit savings products.
The potential good news might be however that people are incentivised not to hoard cash on deposit but either to spend it in the economy and/or invest it more productively, for example in pension-related instruments such as equities which provide the economy with a boost.
It could be said that this has already been happening, as in the recently published Ocean Finance Pension Survey, 37% of respondents stated they had increased their pension payments which may illustrate their need to get a return on the money they do have rather than it being an indicator of them having more ‘free cash’ available to them.
For Joe Citizen: As stated above these are not normal times and indeed as has been stated elsewhere ‘we are all in this together’. We effectively own the banks and given that even distressed personal debt is now being effectively collectivized through personal insolvency, it is no longer a zero sum game where one can benefit whilst your unlucky neighbour takes a hit. However, an interest rate cut is nearly always a good prescription in any economy where growth is very weak.
All in all, the ECB rate cut gives us in Ireland some cheer and whilst it might not have put a smile on Angela Merkel’s face, she will be happy to suck it up for now as she knows that her teutonic monetary philosophy will face sterner tests down the road.