While the sovereign debt crisis continues to drive up the cost of borrowing for governments across Europe, another kind of borrower is actually set to benefit from the fiscal uncertainty.
Tracker and standard variable rate (SVR) mortgage-holders have been granted a reprieve from interest rate hikes which had been expected to kick in later this year. The continued volatility in the eurozone means that the European Central Bank (ECB) is now expected to keep interest rates at the historic, emergency low of 1% for the rest of the year and probably well into 2011. This is good news for tracker borrowers who will now have some extra breathing room before their repayments start to increase again, and for SVR holders who will only have their bank's margin-related hikes to deal with.
Be warned, however, that the reprieve is temporary: the ECB will eventually have to start normalising rates as recovery stabilises.
Analysts had been predicting that the ECB would start gradually increasing the base rate in the third quarter of 2010 as economic recovery bedded in and growth strengthened. However, the Greek debt crisis and the risks of contagion have significantly changed the playing field and affected the immediate future of interest rates, said Simon Barry, senior economist with Ulster Bank.
"We have had a significant shock to the system which means that financial conditions are under a bit more pressure," he said. "The risks to the outlook are that bit greater and the other factor, of course, is that one of the implications of everything that has happened in Greece is that governments have had to get more serious and quicker about dealing with their money gaps. The market view now is that interest rates can be left a bit lower for a little bit longer."
Currently, the average forecast is that rates could start to increase in the first quarter of next year, though the ECB may wait until well into 2011 before it makes a move. It is fair to say that we are in an unusual economic environment, however, and there are a couple of factors that could force the ECB's hand sooner than expected: the possibility of inflation caused by the bond purchases included in its €750bn rescue plan, and consequences of a declining euro.
The ECB is already taking evasive action to ensure its rescue plan does not spur inflation. However, the fall in the euro's value is a double-edged sword. The boost to competitiveness that this will bring will stimulate exports – there are already positive signs in this regard – which is vital if Ireland and the eurozone countries in general are to return to strong economic growth. On the flip side, a devalued euro means that imports will be more expensive which will, in turn, drive inflation upwards. It's the ECB's job to control inflation and it will increase rates accordingly.
"The corollary of all of that is that once the economic environment begins to normalise, then they will have to normalise the interest rate," said Barry. "The ECB will be fully cognisant of the fact that interest rates at these levels are just too low and that if you don't adjust them, in the medium to long term you will have an inflation problem. Like any good central bank, they will not wait for that inflation problem to emerge before raising interest rates."
Friends First economist Jim Power believes that inflation is unlikely in the current environment and that the ECB may not move at all for another 18 months, even if the core economies start to power ahead of struggling peripherals such as Ireland and Portugal.
"Given what we are seeing across Europe at the moment in terms of the sovereign debt crisis but also in terms of the economic dynamic or lack of it in the peripheral countries, there is no way that the ECB can contemplate increasing rates for the foreseeable future," said Power. "Interest rate increases have gone off the agenda and I think it could remain that way for the duration of 2011. I would not be shocked if we ended 2011 with ECB rates at current levels."
So does this mean that people who moved to long-term fixed rates to avoid interest rate hikes last year jumped too soon? Not so if you were on an SVR, said Karl Deeter, operations director with Irish Mortgage Brokers.
"In terms of base rate hikes, people may have been jumping the gun but all you have to do is look at what the banks have been doing otherwise," Deeter said. "Those who aren't on trackers have already seen that we are entering a world where banks will require more on margins on lending – they are going to be much higher from now on. Last year was really the window for getting yourself a good long-term fixed rate but it is not too late to look around and lock into something decent if that is what you want to do, or you can ride out the rate hikes."
Anyone considering fixing now should be conscious of the disparity between rates available to new and existing customers, said Ciaran Phelan, chief executive of the Irish Brokers Association.
"New borrowers who have entered the market in the last six months have benefited from interest rates of 2.8% fixed for two years and 3.19% fixed for three years," Phelan said. "They benefited because the banks themselves have increased their own margins and these customers have protected themselves from two quarter-per cent increases. However, for those customers who have mortgages with certain banks – those that have curtailed their lending – the gap between fixed and variable rates could be the difference between 5.5% and 2.75%. Therefore, fixing is not a credible alternative."
As ever, it should be noted that if you are on a tracker, you should switch to a fixed or SVR only if you have a very good reason for doing so.
Similarly, if you are thinking of opting for a fixed rate, think carefully about your attachment to your home. If there's a chance that you might want to move within the fixed-rate period, it is best to go for something with a shorter term or to stick with an SVR. The cost of breaking out of a fixed rate is prohibitive at the moment and is likely to remain so.