Since July last year, the European Central Bank has increased interest rates by 4.5% in an attempt to combat rampant inflation.
Mortgage holders and other borrowers certainly felt the impact in their pockets, as banks and other lenders steadily passed some of that on to customers.
But anecdotally at least, depositors feel they are getting a raw deal and those lucky enough to be able to put some money away in savings accounts are not reaping the benefits of higher returns.
Does this stand up to scrutiny though?
What are the facts about the level of impact of rising interest rates on deposits and mortgages?
What are the factors influencing banks’ decision-making about all of this?
So where do Irish banks’ interest rates stand now?
When it comes to mortgages, the latest ECB data shows that those with home loans in Ireland were paying an average of 4.24% in October.
This compares to the eurozone average of 3.97%, giving Ireland the eighth highest mortgage rates among all euro members and representing an improvement on recent years where Ireland has regularly been among the steepest.
Turning to deposits, the average interest rate offered to savers in Ireland who were willing to hold on to their money for a certain period was 2.59% in October.
This is lower than the average of 3.27% across all eurozone member states, leaving Ireland in sixth place in terms of average term deposit interest rates.
Given that interest rates have risen 4.5% over the past year and a half, on the face of it this seems to indicate that depositors here are being exposed to the change, while mortgage holders are suffering almost the full effects.
Is it that simple?
not exactly.
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But ECB data shows that between May 2022 (before interest rates started rising) and October this year, average mortgage interest rates in Ireland rose by just 1.45%, the second-lowest pass-through rate in the eurozone.
This compares to an average of about 2.2% in the euro area as a whole.
On the other hand, looking at savings, between May 2022 and October this year, the average rate offered on deposits rose by 2.85% – leaving Ireland in the middle of the eurozone table.
These two pieces of data put a slightly different spin on things, showing that when it comes to mortgages, customers in Ireland have only felt the effects of about a third of the ECB’s total interest rate rise so far.
But when it comes to deposit rates, they got two-thirds of it.
So, what are the main factors that influence the amount of ECB interest rate increases that banks pass on to depositors and mortgage holders?
The first point to remember is that there is generally a gap between what the ECB does and when banks react.
“With respect to depositors, we are starting to see some interest rate increases being passed on, but there is some catch-up room for the euro area, and she expects that as we get into the new year, that will start to show up,” said Dr. Loretta O’Sullivan, chief economist at EY. during”.
She added that for mortgages, many borrowers here are getting fixed interest rates, so they are also not yet feeling the full effects pass through them.
“A lot of people are locked into these contracts, which are short-term in nature, and when they start to exit, we will see mortgage holders facing a higher repayment burden in the medium term,” she claimed.
On the savings side, another big impact is whether banks need to increase their deposit base in order to fuel more lending.
At the end of October, Irish banks held €303 billion in deposits, a figure that jumped during the pandemic and has remained high since, as households squandered money they were not in a position to spend due to Covid restrictions.
The exit of Ulster Bank and KBC Bank Ireland from the banking system here also led to savings moving to other banks, swelling their deposit base.
The result is that banks here are not really seeking large amounts of new deposits because they have too much liquidity, and so they price interest rates in a way that does not attract excessively more money.
“Irish banks are flush with money at the moment,” said Darragh Cassidy, head of communications at switching site bonkers.ie.
“They really don’t need more…they simply want to lend and make money. They don’t want to take deposits that obviously cost them money.”
Another factor, when it comes to mortgage rates, is that Irish banks use these abundant deposits to fund lending.
This means that lenders here will not have to borrow as much from wholesale markets at increasing costs as ECB interest rates rise, meaning they are able to keep their mortgage interest rates slightly lower than their European counterparts.
So, in some respects it is safe to say that mortgage interest rates have remained low partly at the expense of deposit rates.
Brian Hayes, chief executive of the Irish Banking and Payments Association, said: “There is a balance to be struck between what banks charge for money on one side of the balance sheet and what they provide on the other side.”
“And I think what we’ve seen this year in terms of deposits and savings is a very significant increase in the Irish deposit market.”
“I think Irish banks have moved to increase the savings rate on deposits of one year or more. But as I said there is a balance to be struck, and on the other side of the equation if you look at the 4.5% rate with the ECB increasing over the last 18 to 20 months or so That being said, we are the second lowest interest rate rise in the Irish lending book.
Politics and the general public’s perception of banks are another big reason why mortgage rates remain low.
Irish banks have come under intense criticism and scrutiny in the wake of the financial collapse more than a decade ago.
Both AIB and PTSB remain partly in state ownership following bank bailouts.
Thus, exposing 720,000 mortgage holders to the full effects of a 4.5% increase in interest rates over a relatively short period would not have been well received by the general public and therefore politicians, as it would likely have led to a significant rise in arrears.
This does not mean that banks take instructions from the government, but in the banking sector where public confidence remains low, political sensitivities remain high.
“If you asked someone who they would identify with, I think they would say borrowers and potential first-time buyers rather than someone with €20-30,000 in savings,” Darragh Cassidy said.
“And while there was a little bit of pressure on the banks to increase interest rates over the summer, the banks themselves have largely said that we are trying to keep mortgage interest rates as low as possible so that people don’t fall into arrears, so that people don’t fall behind on their repayments.”
“But the consequence of this is that we will not have very high deposit interest rates. I think this is the right solution.”
But banks make huge profits. Couldn’t they use some of that to lower mortgage rates further and increase what depositors get?
It is true to say that banks have become very profitable again.
Bank of Ireland reported half-year profits in July of more than €1 billion, AIB reported profits for the first six months of the year of €854 million, and PTSB made €26 million over the same time frame.
But the industry says that for many years, during a period when interest rates were at their lowest, profits were low or nonexistent.
While the ECB’s negative deposit rates, which resulted in banks being charged fees for holding money in Frankfurt, have not been fully passed on to household depositors.
Brian Hayes said in defense of the sector: “Bank profitability is important because bank profitability and capital are two sides of the same coin.”
“If you don’t have profit, you don’t have capital. If you don’t have capital, you won’t have new loans. If you don’t have new loans, you won’t have new investment.”
“It’s a cyclical business over a period of time. Yes, profitability has come back, after a decade of a longer period of low interest rate environment that led to very declining profitability.
“And of course, banks’ profitability and capital are the first line of defense in terms of absorbing loss in circumstances in which the economy turns and loans default.”
However, it should be remembered that AIB and Bank of Ireland have both paid dividends to shareholders in recent years – so building capital is not the only consideration when it comes to dividends.
Is competition a factor in all of this?
There is no doubt that competition is an increasing factor.
The Irish banking landscape has shifted seismically in recent years, with Ulster Bank and KBC in decline.
The result is a sector that includes just three major retail banks, a credit union sector, and a handful of small non-bank lenders and fintech companies.
So the competition when it comes to deposit and mortgage interest rates is not what it used to be.
In August, the European Central Bank’s chief economist, Irishman Philip Lane, acknowledged the important role that banking competition plays across the eurozone when it comes to this issue.
“It doesn’t happen to the same degree in all European countries, because obviously banks will raise deposit rates more quickly if they face competitive pressures and also if they are in an economy where there is a lot of demand for loans, so they can.” “We want to raise financing in order to provide credit,” he said in an ECB podcast.
“So in those European economies where there is less demand for loans or where there is less competition, it happened less.”
There are some attractive options on offer for savers who are willing and able to hold on to their savings for a year or more.
But those with deposits in demand deposits or current accounts will continue to attract relatively low interest rates.
“If you want to beat the banks and if you’re that bothered that the banks are making big money and big profits, look at moving your money into savings accounts with better returns,” Darragh Cassidy said.
So, amid all this context, what are the chances of banks’ mortgage and deposit rates increasing in the coming months?
The European Central Bank’s Governing Council meets again on Thursday to consider its next move on interest rates.
With eurozone inflation unexpectedly falling to 2.4% in November, the strong expectation now is that they will leave interest rates unchanged in the new year and consider starting the process of lowering them again sometime in 2024.
“This is because it has already achieved what it wanted to achieve in 2023,” said Loretta O’Sullivan, chief economist at EY.
“This has suppressed inflation in the eurozone. So, the inflation rate estimate for November is 2.4%. This number was in the double digits a year ago. So, it has come down significantly. This has been helped by the sharp decline in energy prices.” As well as through the 4.5% cumulative increase in European Central Bank interest rates.
“So the general view now is that they are done hiking.”
Because of this time lag between the ECB announcing interest rates and Irish banks passing this on to mortgage and deposit products, it is possible that we will see further interest rate changes by Irish lenders over the coming months.
But for now, while all the above factors remain relevant, Irish banks are unlikely to tip the balance of interest rates in either direction in any meaningful way.