July 21, 2022 will be marked as a turning point for the Union’s economy: the day an atypical monetary policy on the Old Continent ended. The European Central Bank (ECB) thus begins the normalization of interest rates with the largest increase in 22 years, 0.5 points.
The turn of the helm was predictable, all that was needed was to set a date, and it will hit the pockets of consumers: on the one hand, with increases in financing costs, which can curb spending. And also with other positive effects like the return of deposit yield. Although the great effect sought is that it moderates an inflation that continues to run wild in Europe. Despite expectations, the Eurobank is still cautious and specifies that these effects will not be immediate with the first increase of 50 basis points.
the most expensive mortgages
Where the rise in rates will be felt first is in mortgages. In fact, it’s been going on for months. because the market started discounting hikes by the messages that the ECB has slipped. This is why the 12-month Euribor, the indicator to which most of these loans refer, turned positive again in April and closed at 0.852% in June. “It has been rising for months because the market discounted those increases. This will affect the typical Spanish family, as they have the mortgage as their main expense,” says Leopoldo Torralba, economist at Arcano Economic Research. A trend that is not going to stop now.
Despite this, it is necessary to distinguish between different mortgages, as it will not affect them all in the same way. On those which already exist, the blow will be carried by those which have a variable rate and are referenced on the Euribor. According to the Spanish Mortgage Association (AHE), at the end of 2021, Spain had 5.5 million outstanding loans and three-quarters (4.1 million) had variable interest. And it is estimated that most of them (around 90%) are indexed to the 12-month Euribor. This means that the fees are recalculated periodically (usually once a year) based on the evolution of the index since the last review. And this, over the months, will result in an increase in the cost of these credits. Compared to the previous year, the Euribor ended in December at -0.502%, the second lowest average in history. “The market expects a 12-month Euribor of around 2% to be reached by 2024, with a gradual rise until it reaches that point,” recalls Torralba.
Fixed rate mortgages already taken out are exempt from these fluctuations. However, the new ones that are made official at this time will also pay the increase, since the banks have made these offers worse (they raised the fixed rate they offer due to the new economic environment) and improved the spread of variable rate mortgages to protect against the ECB hike.
Consumer credit will be the other major item where the increase in spending will be felt. In short, everything that involves asking for financing will become more expensive, hence the risk that a sudden rise will slow down consumption and therefore the economy. In the case of these loans, of a lower amount than mortgages, their price will not increase due to the annual revisions, since these generally have a larger fixed component.
Despite this, the blow will exist. Concretely, the setback will come for those who are now tuned, who will have a higher differential. “This will affect new loans because they are priced according to interest rates,” adds Torralba. This will also be felt in companies with a reduction in their investment capacity.
Return on savings
So far, all elements have in common an increase in costs due to the increase in rates. However, there will be sections that, if the theory holds true, will end up benefiting consumers. For example, those who have savings. If for people in debt – or who have to – this will mean a higher outlay, for savers the rise in rates will be a bottle of oxygen. “These are two sides of the same coin: if some pay more for their liabilities, others will receive more money with low-risk assets”, explains the economist Arcano.
In this way, the return to profitability on deposits will accelerate. As well as other investment alternatives, among which government bonds stand out, which will regain attractiveness by paying higher interest – conversely, it will cost the public coffers more to pay the debt , as evidenced by the growth in prime risk. This, in practice, will encourage savings, which until now has been penalized: it will be more interesting to keep this money locked up with a guaranteed return rather than to move it towards riskier investments or to devote it to consumption.
The main reason for the rate hike is to contain galloping inflation, in particular due to the energy crisis generated since the Russian offensive on Ukraine. In Spain, the CPI ended June at 10.2% compared to the previous yearwhile in the euro zone it rose to 8.6%.
In this context, the rise in rates should make it possible to contain the upward spiral in prices and bring them closer to the ECB’s objective of around 2% inflation. “The number one priority is to fight inflation, which impoverishes us in the present and conditions our future,” said a spokesman for the Spanish Association of Banks (AEB). On paper, this seems very simple: it is a matter of raising rates to a neutral rate. That is, one in which it does not stimulate the economy, but does not depress it either. A very difficult balance to achieve and in which any misstep by central banks or past braking could derail economic activity.
Thus, the rate hike initiated by the Eurobank is a very complex cocktail. On the one hand, it will reduce consumption and investments. And on the other hand, it will make saving more profitable and help moderate inflation. The question is whether the rise in rates manages to lower the CPI to the point of offsetting the increase in the burdens it will entail for indebted households. “The balance will be that the increases are not exaggerated and make it possible to lower inflation without excessively damaging the economy”, summarizes Torralba. All this with an underlying risk: the threat of recession and that this increase takes away from the strength of job creation and the economy as a whole at a time of great uncertainty due to the war in Ukraine.