Over the course of the past 12 months consumer prices in Europe have increased at a rate not seen in the previous eight pre-pandemic years together. This makes the European Central Bank (ECB) to come up with ways to battle an inflation that has never been seen in the history of the monetary union.
How aggressive are ECB’s plans to battle inflation, and will Latvian residents be forced to pay more for their mortgage loans as a result of these plans?
Since 2012 and up to the start of Covid-19 pandemic residents of Eurozone have gotten used to living without a noticeable inflation. It is during this period of time – eight years – that consumer prices increased by almost 9%. This is nearly as much as inflation’s rise over the course of the last 12 years. Consumer price increase observed in May exceeded 8%, setting a new record in the history of the monetary union. May’s inflation in Germany was the highest it has been since the 70s, comments CBL Asset Management economist Simona Striževska.
Although energy resource and food prices remain the main force behind inflation in Eurozone member states, price rise has become more rapid in other categories of goods and services. Inflation as a phenomenon is rooted in economy and people’s minds. If nothing is done, it creates risks of a stronger inflation and lower quality of life in the future.
In the last decade ECB has gotten used to dealing with low, not high inflation. This is why the institution has ignored the threat of inflation to the last moment. The start of war in Ukraine and the leap of prices of resources increased the post-pandemic inflation pressure. This forced ECB to look towards a restricting monetary policy. To battle to record-high inflation, ECB has started preparing the soil for the first rate increase in more than ten years in spite of the expected slowing of the economy in the region, explains Striževska.
Based on reports from ECB representatives, the first two euro rate increases may take place in June and September. This may put an end to the era of negative rates in Eurozone. Together with ECB base rates, other rates will increase, which directly affects private borrowers in the monetary union, including Euribor – the interbank interest rate that composes the variable part of many loans. Loans will become more expensive, restricting demand and inflation in the process. Even now governments have to pay more to borrow money from financial markets.
Generally, more than half of loans issued by commercial banks already include the variable part, which directly depends on the direction of ECB’s monetary policy. However, for mortgage loans such a ratio in Eurozone is much lower. On top of that, in recent months it accounted for no more than 15-20% of newly-issued loans. The situation is different in Eurozone’s Nordic and Baltic States, as well as Finland – most mortgage loans include the variable part. If Euribor rate becomes positive, loan maintenance costs may increase not only for new mortgage loan users but existing ones as well.
While Euribor rate remained in the negative zone since 2015, there was no need to pay attention to the variable part of loans. It was close to zero. If Euribor rate increases o 1%, the monthly mortgage loan repayment amounts for loans with a remaining term of about 20 years may increase by an average of 10%. Payments for loans with about ten years left may increase by an average of 5%.
With transparent ECB deposit rate reaching 0% as opposed to -0.5% now, ECB’s monetary course so far remains unclear. ECB may not stop at what it has accomplished so far. Members of the financial market predict that ECB will continue increasing rates. The three-month Euribor rate may come close to 1% by the end of the year and stabilise within 1.5% – 2.0% in the next two years.