Bank issues warning to borrowers

INTERNAL threats to the stability of the economy have increased, the Central Bank warned yesterday.

Rampant house prices and the threat of rising interest rates meant that “fundamental threats to the economy have increased over the past six months”, said Tom O’Connell, assistant director general of the bank.

Mr O’Connell, speaking at the launch the bank’s Spring Quarterly Bulletin, said it had been anticipating house prices to slow to about 6% this year, but instead the figure for this year will be double that figure or higher.

The low interest rate regime is coming to an end and the bank is seriously concerned borrowers and lenders have not taken that reality fully into account.

In its bulletin, the bank notes mortgage borrowing accounted for three quarters of personal sector borrowing by the end of 2005, while the ratio of personal debt to disposable income has increased from 115% to 132% over the past 12 months.

Given the threat to interest rates and the amount of debt being built up by individuals, it warned lenders and borrowers “take into account the current still very low level of interest rates” and that this cannot continue “indefinitely”.

Bank interest rates are set to rise by another 1% over the next 12 months and the Central Bank warned that a further 1% rise on top of that cannot be ruled out.

While it was not making an interest rate forecast, Mr O’Connell pointed out that ECB president Jean Claude Trichet said a neutral ECB bank rate would be close to 4.5% going forward. The current ECB rate is 2.5% and the markets have stitched in a further hike of 1% by this time next year.

The Central Bank’s concern is that as the European economy picks up further, the ECB will add another 1% to rates over time.

The Central Bank raised its 2006 economic growth forecast slightly despite reservations over falling productivity and concerns dependence on construction posed “a significant risk”.

The bank predicts GNP and GDP growth of around 5% this year.

Glancing back to last year the bank said employment growth of around 87,000 accounted for almost all of the growth, with productivity rising only marginally.

This was because jobs growth concentrated on labour-intensive building and services sectors.

The bank also said labour costs were increasing at rates well above the eurozone average, and called for future pay developments to protect competitiveness.

On housing, the report said the current level of activity was “beyond what is required” and a contraction would be needed “at some point”. It described the 11% annual increase in house prices in February as worrying.

Because of its lending concerns the bank has set in motion “stress testing” for the banks that paints a scenario of unemployment rising to 10% from its current 4.5%, with interest rates going up by 2%.