Lessons for all Irish homes as US rates rise

Lessons for all Irish homes as US rates rise

By Joe Gill

Rising bond yields in the US may not have many tangible effects on Irish consumers and business currently, but they are a salutary reminder that the price of debt can, and probably will, change.

There is little evidence that interest rates in Ireland are likely to rise in the foreseeable future, as the ECB retains a highly accommodative monetary stance, in support of a fragile eurozone economy.

However, there are some straws in the wind worth noting.

Bond yields in Italy, and in some other EU countries, have begun to march upwards in recent weeks, as worries grow about government spending.

Italian spending plans, in particular, are worrying investors and they, in turn, are demanding higher prices in the form of coupons, for additional bond debt.

The rise in US bond yields looks like continuing, as the US Federal Reserve works to bring monetary finance back to what it deems normal levels, in the aftermath of the global financial crisis that began in 2008.

Some in the Fed think long bond yields should rise to 4% or more.

Given the importance of the US in the world economy, and for global competition for capital, these higher rates will elicit responses from other central banks.

Inevitably, it seems, rates could be going up.

For an individual consumer in Ireland, the most pertinent issue, when discussing debt, is their home mortgage.

Years of ultra-low rates by the ECB have produced interest rates on mortgages that are the lowest in many decades.

It has become normal to get loans fixed for three years or more at 3%, and many consumers think that will remain.

If rates do not stay low, the effects could be painful, especially if you do not have a locked down rate.

Every additional, one percentage rise on a €200,000 mortgage loan, over 20 years, will add at least €40,000 to servicing that debt.

Moreover, any rise in mortgage interest rates would be accompanied by higher rates for other types of consumer debt, too, including credit cards.

Adding these consumer borrowing costs together can quickly eat into after-tax earnings.

At a corporate level, too, incredibly low borrowing costs have been widely available for a number of years.

For companies engaged in large capital-expenditure or acquisition programmes, these numbers can add up. A €100m investment programme, funded by a bond with a 3% coupon, will add at least €1m in annual operating costs for every rise of 100 basis points in rates.

That can often make some investment programmes untenable or squeeze returns to levels deemed unacceptable by shareholders and boards.

Of course, rising yields have positive elements, too.

Usually, higher bond yields are caused by strong economic activity, which is stimulating inflation and stretching the economy’s resources.

The higher rates are partly designed to cool everything down and that is evident in the US, currently.

Also, higher rates are good news for savers and those close to retirement.

Savers in Europe, for example, have been living with zero or negative interest rates for a few years, effectively being punished for having cash.

Deposits also play a key role in lubricating the banking system and supporting lending to the broader economy.

Accordingly, attracting and retaining deposits via interest rates should be part of a normal banking package.

For investors and retirees, higher interest rates offer assets that are effectively risk-free, while paying an annual income to their holders.

A 4% coupon, for example, pays a retiree with €500,000 of assets €20,000 per annum, compared to just €5,000 when bond yields are at 1%.

This means those retiring have to assemble a smaller amount of capital to achieve a desired annual income.

It also helps alleviate pension funding pressures on corporations and governments.

Joe Gill is director of corporate broking with Goodbody Stockbrokers. His views are personal.

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