Lower interest rates a benefit to consumers

The debt woes of Ireland are well known. One of the biggest legacies of the 2000s is the burden of debt now carried by both households and the government.

The credit binge of those years saw household debt as a percentage of disposable income more than double to over 200% between 2002 and when it peaked in 2010.

Due to a combination of fiscal imprudence during the bubble years and bank rescue costs after it burst, Government debt also spiralled, going from 25% of GDP in 2007 to peak at 120% in 2012.

Despite some easing in this over the last few years, debt levels remain high at about 176% of disposable income for households and 100% of GDP for the State.

With both households and the Government obliged to service such heavy debt loads it is surprising that both are in the process of loosening their purse strings.

Recent figures indicate that consumer spending was 3% higher in the first half of this year than at the same time last year. Households have clearly started to spend again.

Meanwhile, the Government is planning to announce its second consecutive expansionary budget in less than two weeks.

Disposable incomes, which collapsed in the years after the crash due to a combination of falling earnings and rising taxes, have only just started to show signs of recovery.

Average earnings are around 2% higher in the first half of this year compared with last year, while a modest reduction in income-related taxes in last year’s budget has also helped.

But the latest figures suggest that disposable income remains 12% below the pre- crash levels meaning both are still insufficient to support a recovery in consumer spending.

What has really changed the dial is interest rates. Over the past seven years the ECB has consistently reduced its base rate. It has come down from a high of 4.25% in 2008, to its current record low level of 0.05%.

For households lucky enough to be on trackers, which account for just under half of all mortgages, the benefits have been substantial, with the reduction in the ECB rate being passed directly to the borrower.

More recently, even those on variable rates have begun to feel a positive impact, with the banks passing some of the reduction on to borrowers in the past year.

This means that the amount of disposable income that is required to service debt is significantly less, around 50%, than it was in the boom years.

This has helped boost both discretionary income and importantly it has given the consumer the confidence to start spending again. Low interest rates have in turn allowed the Government to borrow at record low levels.

This saw the IMF loans refinanced at a lower cost earlier this year and allowed the raising of additional debt over the past 12 months at cheaper rates than the Government had expected.

Indeed, this is the main reason that Government expenditure is coming in lower than forecast.

Friday’s exchequer figures show that €441m of the €502m expenditure undershoot in the year to date is due to lower interest costs.

The ECB hasn’t just reduced interest rates to close to zero, it has also been effectively printing money to buy a range of bonds in the market.

This ‘quantitative easing’ also helps keep the costs of borrowing, for governments and large corporations who have access to debt market funding, to stay low.

The reason for the ECB’s largesse is, of course, not to bail out the Irish consumer or its Government but to encourage enough growth in the Eurozone to stave off deflation.

This has not as yet had much success with prices in the region actually falling again in September.

This has led to increased speculation that, the ECB will actually have to expand its bond buying programme. It also makes it less likely that interest rates are going up anytime soon.

For a country as indebted as Ireland this is a bit of a double-edged sword.

It is clearly good news for Irish consumers who have more discretionary income while rates remain low. It also means there will be more time for disposable incomes to recover enough to be able to bear higher debt servicing costs, when rates eventually rise.

However, low inflation makes it more difficult to reduce the actual debt levels and the danger is that consumers, businesses and governments will get overly accustomed to lower rates when this is just a temporary, albeit elongated, situation.

  • Juliet Tennent is an economist with Goodbody Stockbrokers


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