Is the ECB going to raise rates by 0.75%?

The European Central Bank surprised many by introducing a half-percent rate hike in July.

Given that the ECB has not raised rates in more than a decade – and given the alarming pace of deterioration in the eurozone’s growth outlook – speculation was focused on a modest 0.25% increase.

However, the regulator appears to be firmly focused on getting inflation under control in the eurozone first.

“Price pressures are spreading to more and more sectors,” ECB President Christine Lagarde said after announcing the rate hike last month.

“We expect inflation to remain undesirably high for some time.”

And indeed, it remained undesirably high. According to the latest data from the EU statistics agency Eurostat, prices in the eurozone rose by a record 9.1% in the year to August.

This has fueled fears that inflation could take root in the economy, and there are predictions that things will get worse in the future.

Although oil prices have fallen recently, gas prices in Europe are rising rapidly.

They are now about 10 times the average for the past decade.

Stockbrokers Davey said this week that inflation in Ireland could reach double digits in the coming months.

Economists of the American bank Citi predict that inflation in Great Britain may exceed 18% at the beginning of next year.

A divided council

This level of inflation – if it occurs – is likely to be replicated across the eurozone.

No doubt that played into the minds of ECB Governing Council members ahead of their rate-setting meeting next Thursday.

While the bank has given some guidance in the past on how they might move – a practice known as “forward guidance” – they have backed off for now in light of the rapidly changing inflationary environment.

At a meeting last month, Christine Lagarde said that from now on the bank would take decisions “month by month, step by step” and it would be “data dependent”.

So to some extent we don’t know what the ECB is going to do, but some members seem to have already made up their minds about the data.

Isabelle Schnabel, a German economist and member of the ECB’s governing council, said the inflation outlook had not changed since the last rate hike, indicating she was in favor of another sharp rate hike.

Dutch Central Bank President Klaas Knoth said he favors another hike of 0.5% and possibly 0.75% at next week’s meeting.

Others said a three-quarter point increase should at least be on the table for discussion.

However, the ECB’s chief economist and former governor of the Central Bank of Ireland, Philip Lane, argued this week that the ECB should raise rates at a “sustainable pace”, which seemed to indicate that it would not support a 0.75% hike.

He said he believed it would be better to move in “smaller steps” over the coming months, allowing more time to see how the economy develops.

Unprecedented

If the ECB decides to raise interest rates by 0.75%, it would be the first time its borrowing rate has risen by such a wide margin since the creation of the euro in 1999.

By July, the borrowing rate had not risen by 0.5% since mid-2000.

This is an indication of the scale of the inflationary problem facing ECB policymakers at the moment.

However, this would not be a move to the left in the current rate hike cycle around the world.

The US Federal Reserve has made two consecutive 0.75% hikes in recent months, with the possibility of a repeat this month.

So a 0.75% increase is certainly not out of the question here.

What will this mean for mortgages?

Apart from mortgage holders who are automatically hit by rising interest rates, major bank lenders have refrained from raising rates on their variable and fixed rate products after the ECB announced a rate hike in July.

Avant Money, which has some of the cheapest rates on the market, recently announced its second rate increase this year, ranging from a 0.3% three-year fixed rate increase to 2.25% to full interest on long-term fixed rates up to 30 years.

It also increased its variable rates.

Last week, ICS Mortgages announced another whopping 1.25% rise for its variable rate products, following the lender’s decision to cap new home loans at two and a half times income.

Finance Ireland has also raised rates on its fixed rate products in recent months.

​​​​​​While the exact size of any future move by the ECB is unclear, we can say with some certainty that interest rates will rise further in September and lenders will almost certainly pass this on to their variable rate customers and possibly further some of their fixed rate products too.

According to Alison Fearon, managing director of Switcheroo Mortgages, the full 0.75% increase – if delivered and passed – would add around €100 a month to the average €250,000 mortgage.

However, she said the biggest shock was likely to come for those coming to the end of their fixed-rate period and switching to the lender’s standard variable rate (SVR), which is as high as 4.5% with some lenders.

A full 0.75% increase would push the rate above 5%.

“Over the past few years, many customers have taken short-term fixed rates of around 2.25%, which are due next year. If they do, they could face a jump in interest from 2.25% to 5.25%.” Ms. Ferron said.

“For the average mortgage customer, this will be an increase of €400 a month or almost €5,000 a year,” she calculated.

It would be logical to re-fix or even change provider, but some may find it difficult to demonstrate their ability to afford a mortgage with a new provider amid rising costs of living and limited pay rises, Alison Fearon points out.

That could lead to many falling into what she called the “SVR trap,” which she said could be financially devastating for people who are already struggling.

“Customers in this tight spot could see their overall cost of living rise by €8,500 a year compared to a year ago,” she said.

She urged those on fixed rates to explore the possibility of breaking and redoing to give them a longer fixed period.

In some cases, the provider does not charge a break fee. However, it is necessary to consult with them first.

What about trackers?

Most owners of tracker mortgages have done well for many years.

Since the ECB’s base rate has been at or near zero since the middle of the last decade, maintaining the tracker has been very cheap by historical standards. Now that is changing.

From this month, they will pay a surcharge of 0.5% of the previous rate.

Joey Sheehan, head of credit at MyMortgages.ie and author of The Mortgage Coach, has done some sums on this.

Using a borrower with €300,000 of debt on a 1% tracker mortgage with 20 years remaining, they would have monthly payments of €1,379 by now.

“A 0.5% interest rate rise would increase this to €1,447, an annual increase of €816, or €16,320 over 20 years,” he calculated.

At least another 0.5% can be expected next week, bringing the mortgage lender’s tracker to 2% – or a full percentage point gain over several months.

“A 1% rise in the ECB’s benchmark rate would increase monthly payments to €1,517, an annual increase of €1,656 or €33,120 over 20 years,” Mr Sheehan calculated.

How high can the stakes be?

At the beginning of the year, ECB observers planned to increase the rate by 0.25% by the end of the year with the possibility of returning the rate on deposits (then -0.5%) to zero.

This was already achieved in July, and with speculation centered on a 0.75% rate hike next month – and with two more rate meetings before the end of the year – the deposit rate could be above 1% by Christmas.

Based on what the more hawkish elements of the Governing Council are saying, the deposit rate could be closer to 2% by then and the borrowing rate could be as high as 2.5%.

“The inflation problem in Europe at the moment is so big that I believe it is our duty to raise rates every six weeks until inflation stabilizes,” Dutch Governor Claas Knoth told Dutch national broadcaster NOS last week.

In 2008, inflation rose to 4% and the ECB raised interest rates to 4.25%.

Inflation at 9% – and possibly rising – makes it difficult to predict where rates might end up.

The more dovish elements of the ECB’s Governing Council, including Philip Lane, are calling for restraint.

They advocate taking a step back and looking at the bigger picture.

In the context of a recession or economic downturn, consumer and business demand will fall, acting as a lag behind inflation itself.

In this scenario, the ECB may have to move more slowly. After all, when they raised rates in 2011, they had to reverse the increase within months.

The result of next week’s meeting will be very revealing. If the ECB chooses to raise within the larger range of expectations, it will mean that the hawks are winning the inflation argument, and sharper rate hikes can be expected before the end of the year and into next year.

The era of cheap money is over – at least for the foreseeable future.