Central Bank: Inflation and high interest rates could expose vulnerabilities in economy 

The Central Bank expects household financial stresses to rise modestly but many are proving resilient in the face of high inflation so far. 

Governor of the Central Bank of Ireland Gabriel Makhlouf. Photograph: Leah Farrell / RollingNews.ie

Persistently high inflation eating into incomes along with high interest rates and economic slowdowns have all been identified by the Central Bank as risks to the Irish economy.

According to its latest Financial Stability Review published on Wednesday, the Irish economy has proven resilient, despite global economic issues, with domestic growth forecasts improving compared to late last year.

However, Central Bank Governor Gabriel Makhlouf said that “we must remain mindful” of the range of potential adverse outcomes that could materialise.

The Central Bank said that while many are stretched by the cost of living, households and businesses are proving resilient to the inflationary shock so far. Under the current outlook household financial stresses are expected to rise modestly.

“Our assessment is that, if the economy continues to evolve in line with our expectations, we are likely to see only modest increases in financial stress among domestic borrowers, despite clear challenges for some groups of borrowers,” Mr Makhlouf said.

Although borrowers are being hit hard by increasing interest rates, Mr Makhlouf does not believe the rate increases are going to stop soon. 

He said that he expects the European Central Bank to increase interest rate increases again this month and next month and that he does not expect the rates to drop again anytime soon.

He said it would be a "question of judgement" whether there would be further rate hikes after the summer. 

"Once we reach what I describe as the top of the ladder of increasing interest rates we'd like to stay there for a while. I’m not going to speculate how long that will be.” 

The ECB has raised rates by a combined 375 basis points in the past year in the hope of taming inflation.

In addition, Mr Makhlouf warned against “untargeted” mortgage interest relief proposals for struggling homeowners saying they can be counterproductive.

He said that if such a measure was to be brought in, then it should be targeted at the most vulnerable and tailored in the most precise way. It also should be temporary.

Mr Makhlouf said that when Governments are making budget decisions they need to think carefully about the design of the policy as what the “unintended consequences might be”.

The Central Bank's review said that despite a strong economic outlook “persistent inflation and higher interest rates pose risks of an economic slowdown which could expose vulnerabilities”.

It warned that the Irish financial system could face risks due to a global downturn stemming from high inflation, further tightening of financial conditions as well as further geopolitical fragmentation.

“The global financial system remains vulnerable to disorderly market adjustments after a decade of elevated risk-taking, as evidenced by recent turbulence in the banking system.

“Domestically, persistent inflation and higher interest rates could lead to slower growth and expose vulnerabilities, particularly in commercial real-estate markets.” 

The domestic impact of higher interest rates is being seen most evidently in the commercial property market which has seen prices drop 9.4% in the year to the end of March.

In the housing market, weak supply may somewhat mitigate the magnitude of price falls but increases in mortgage interest rates are starting to slow demand and have contributed to a flattening in house prices in recent months.

The Central Bank said that the Irish public finances are in a strong position but the concentration of corporation tax receipts amongst a small number of firms means prudent fiscal planning is needed.

Since the last review by the Central Bank, there has been increased volatility in the global banking sector with the collapse of a number of banks in the US and Credit Suisse.

The review said the banking system has capacity to absorb potential future shocks as profits continue to grow due to higher interest rates.

“Domestic banks currently have headroom above regulatory capital and liquidity requirements which provides capacity to absorb shocks, while profitability is expected to increase through the interest margin channel,” the review said.