Global interest rate worm preparing to turn

FROM the perspective of borrowers in Ireland, the last few days have been quite interesting.

On Wednesday morning the Central Bank of Ireland released lending data, which vividly demonstrated the borrowing binge in Ireland continues at a frenetic pace.

Later that day, the US Federal Reserve implemented its first interest rate increase in a long time, signaling that the global interest rate cycle is turning.

The two events are related because obviously the bigger the borrowing binge the more painful the impact of rising interest.

The lending data shows in the first five months of the year private sector credit in Ireland increased by a massive €14.3 billion, with an increase of €3.7bn in May alone. Mortgage credit expanded by €5.6 billion in the first five months of the year.

This level of credit growth, which is pretty unprecedented in Ireland or elsewhere, tells us a few things about the Irish economy:

Firstly, that Irish consumers and businesses are coming back to life and are obviously feeling very confident about the future. This is good news from the point of view of economic vibrancy in general but employment prospects in particular. Secondly, people are still piling into property and it is no surprise that the housing market is set to experience another very vibrant year in 2004.

With the sort of mortgage credit growth we are seeing chasing a limited but rapidly growing housing stock, it is no wonder that house prices nationally are set to increase by up to 10% again this year. For property investors this is very good news, but for those trying to get on to the property ladder it is clearly not quite as good.

The decision by the US Federal Reserve to increase its interest rates by 0.25% is very significant. Rates had been exceptionally low for a protracted period as the US central bank sought to reignite a very moribund domestic and international economy. They have done the job successfully.

With economic vibrancy returning, the process of taking US interest rates back to more normal levels has begun. There is more to come, of that we can be sure.

The big issue of course is if this has any implications for the eurozone and consequently for Irish borrowers. The answer is most probably yes. The rapidly-expanding US economy is giving a growth impetus to the rest of the world and even the growth-resistant eurozone economy is benefiting.

Having said that, growth in the eurozone is still quite modest and unemployment remains uncomfortably high, but the chances are that over the coming months, most probably in the early part of 2005, the ECB will start to take its interest rates up from current low levels of 2%.

Given the amount of credit outstanding, a crude guesstimate is that an increase of 0.5% in ECB interest rates would cost Irish borrowers around €870m. Of course some of this would be given back to depositors, but it would still have a significant financial impact on the economy.

The impact would not be sufficient to cause catastrophic effects, but would still be meaningful.

People who are currently borrowing, particularly for non-productive purposes such as housing, should recognise current exceptionally low interest rates are transitory and they should build into their budgeting exercise, the likelihood that rates could rise by a couple of percent over the next couple of years.

In the days of old, the Irish Central Bank would be apoplectic about such rapid growth in credit, but thanks to EMU, there is not a lot the Irish monetary authority can do about it anymore.

Mr McCreevy has been criticised for the generosity of his SSIA savings scheme.

But critics should remember anything that would promote a savings culture in an economy where borrowing and spending has reached unimaginable heights in recent years should be welcomed.