ECB holds interest rate at historic low of 1%

THE European Central Bank (ECB) left borrowing rates unchanged at their historic low of 1% following its monthly meeting in Frankfurt yesterday.

That decision was in line with expectations. And the markets have already anticipated that there will be no change in rates in 2010 due to the depressed state of the eurozone economy and the absence of any inflationary pressures.

Commenting on the interest rate outlook, Bank of Ireland chief economist Dan McLaughlin said the pace of recovery removes any pressure on the ECB to raise the cost of borrowing for some time.

Given the poor growth outlook for Europe and the fact that inflation is likely to stay low “we now expect the repo rate to stay at the current level until the first half of 2011”, he said.

While stressing “nothing is certain” in the difficult environment, the ECB is likely to spend the rest of the year draining cash from the system in order to bring money market rates up to the 1% level it set some time back.

In Britain the picture is less clear cut due to the fact that inflation is well above the 2% target while the unemployment rate appears to have stabilised.

Mr McLaughlin believes the Bank of England is not too anxious about the rate of inflation and is of the view that it will fall back below the 2% level in the short term.

On that basis “we now expect the first rate rise in the UK to emerge in the spring of 2011”, he said.

In the US the bank believes rates “will still start to rise this year, albeit in the autumn at the earliest”, McLaughlin said.

Despite the ECB’s decision, which was good news for consumers, the cost of mortgages and business debt is rising as Irish banks pay more for the money they borrow in the inter-bank market.

They are now starting to pass on that cost to borrowers because the banks are paying more than what they are charging clients for their loans.

This means many of their loans are costing them money at present, a situation that is not sustainable given their need to rebuild their capital bases.

This week AIB chief executive Colm Doherty warned that higher mortgages were on the way because the bank was losing money on a portion of its mortgage book.

TSB already raised the cost of its variable mortgages by 0.5% in late January.

And it also warned this week of a further rate hike coming down the line as it introduces measures that will boost its capital position to meet tougher international guidelines being put in place to prevent another global collapse of the banking sector.