Ever so slowly, the ECB is unwinding the extraordinary programme of monetary stimulus which it started during the economic collapse. Another step at its latest council meeting means that the ECB’s key interest rate – and thus in rates charged to Irish borrowers – may start to increase in 2019, with implications for households, businesses and the exchequer.
The ECB’s governing council tweaked the wording of the state it issued after its latest monthly meeting, removing a commitment to increase the “size and/or duration”of its bond purchasing programme if necessary in the event of an economic downturn.
Growth
It is buying €30 billion in bonds each month and has committed to continuing until the end of September at least. The changed wording indicates that the ECB is increasingly confident about the outlook for economic growth, with euro zone GDP expected to expand by 2.4 per cent. compared to a previous estimate of 2.3 per cent.
The change was part of the long journey back to normalising monetary policy, according to Simon Barry, chief economist at Ulster Bank in Dublin, who said that while ECB president Mario Draghi played down its significance, the ECB was responding to clear evidence of economic improvement, albeit with inflationary pressures still weak. Mr Draghi also referred to other risks to growth, including the steel and aluminium tariffs being introduced by the Trump administration, of which he was critical.
In the light of the uncertain outlook for inflation, the ECB is still keeping its options open to extend bond buying beyond September, though most analysts expect it to end some time this year. The main questions surround the inflation rate, forecast to be 1.4 per cent this year and next, below the ECB target of close to 2 per cent Draghi commented at his press conference: “Our mandate is in terms of price stability. Victory cannot be declared yet.”
Indicator
A key indicator for the ECB is wage increases and a deal last month between German union IG Metall and employers for a 4.3 per cent rise over 27 months will have been seen as some evidence of a return to normal earnings growth. Still, the absence of strong inflation pressures is a feature of the big developed economic blocs after the crash and it makes it difficult to forecast the outlook for inflation.
The ECB continues to say that its key interest rates “will remain where they are for an extended period of time and well past the horizon of the net asset purchases “( the bond buying programme). This suggests that if the bond buying programme ends late this year it will be well into 2019 before any increase in interest rates – most analysts believe the first move will be in the second half of 2019.
There are a few points to note here for borrowers. The first is that the timing remains uncertain. Rates could start to rise earlier in 2019 if growth and inflation are stronger than expected, while any economic problems or market turmoil could delay the move. The second is that when the ECB starts to move, it will want to continue a gradual increase in rates thereafter, as the US central bank is now doing.
The final point is that long-term market interest rates will start to move ahead of short-term rates. That may knock on to some rise in longer-term fixed interest rates on offer to borrowers and on the cost of raising debt for the State. The era of super low interest rates will not go on for ever, even if it is a very slow march by the ECB back from the emergency measures introduced to combat the crash.
