Home » What Risk Of Rising Interest Rates In The Eurozone?

What Risk Of Rising Interest Rates In The Eurozone?

ECB HQ at Dusk. Photo credit: Dembo / Foter / CC BY-NC-ND
ECB HQ at Dusk. Photo credit: Dembo / Foter / CC BY-NC-ND

Base rates in the Eurozone are at a historic low, encouraging Spanish borrowers to start gearing up again with variable rate mortgages. Rising interest rates could throw a big spanner in the works of the Spanish property market recovery, such as it is. What are the chances of rising interest rates in the next few years?

We recently reported that Spaniards are much more prone to choose variable-rate mortgages than other European nationalities, for example the Germans. This leaves the Spanish housing market more exposed to rising interest rates than other countries.

Fortunately, the chances that the 12-month Euribor rate will turn around and start rising anytime soon are slim, is the consensus view amongst market analysts.

For interest rates to rise, the European Central Bank (ECB, head office pictured above) would have to bring an early end to its multi-billion Euro asset purchase plan, which it introduced only a few months ago. There is no chance of that without a marked improvement in the Eurozone economy and a rising inflation pressures, neither of which show any signs of threatening to take hold.

Market expectations are that the ECB will stick to its programme of quantitative easing (QE) until September 2016, buying €60 billion of public and private debt each month to stimulate the economy and hit its inflation target of just below two per cent. The ECB has stuck to its plan so far.

As long as the Eurozone is flooded with liquidity by the ECB, fixed income returns will remain low. That includes the 12-month Euribor rate used to calculate repayments for the vast majority of Spanish mortgages.

But what if the economy rebounds strongly? In that case the ECB might have to taper its QE programme prematurely, which would drive up interest rates and consequently Spanish mortgage repayments. This is possible, but highly improbable, say experts.

The IMF forecasts growth of 1.5 per cent this year, in line with ECB forecasts, the OECD forecasts 1.4 per cent, and the Bloomberg consensus is 1.3 per cent. They would all have to be wrong and growth would have to jump to two per cent or more for Euribor to rise anytime soon.

What about inflation? Is there any sign of price pressures building? The ECB target is just below two per cent. The last time the ECB raised base rates was July 2011, when inflation stood at 2.7 per cent. But currently the ECB inflation forecast for this year is zero, rising to 1.5 per cent in 2016 and 1.8 per cent in 2017. So they don’t expect inflation pressures anytime in the next two years, not least because of the collapse in the price of oil, currently around $60.

Inflation expectations according to Bloomberg are 1.3 per cent for Germany over the next 10 years. They might turn out wrong, but that’s where they stand today.

So, without stronger growth or rising inflation, Eurozone base rates are highly like to remain low for the foreseeable future. That will help keep the pressure off Spanish borrowers, but could also encourage reckless lending that assumes rates will remain low for ever. Rates are, after all, unnaturally low, and we have to assume they will rise one day.


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