independent

Wednesday 16 April 2014

Pressure on ECB to cut rates again as inflation falls to a record low

European Central Bank president Mario Draghi
European Central Bank president Mario Draghi

PRESSURE for another cut in eurozone interest rates has intensified after a set of figures showed inflation falling to a record low.

The governors of the central banks of the 18 countries – it was 17 members until January 1 when Latvia joined – that are members of the eurozone meet tomorrow, with another interest rate cut likely to dominate the agenda.

An immediate reduction is not expected to be announced at the meeting of the European Central Bank (ECB), but the governors could signal a lowering of the rate in the coming months.

The ECB surprised the markets when it reduced its core interest rate last November.

About 375,000 holders of tracker mortgages gained from that. It meant a saving of about €30 a month for a mortgage holder with a €250,000 home loan.

That cut was prompted by lower-than-expected inflation.

Now the latest figures on eurozone inflation have shown that price rises are so muted that there is a risk of damaging deflation taking hold.

The EU’s statistics office Eurostat said inflation across the 17 EU countries that use the euro fell to 0.8pc in December.

This was down from 0.9pc the month before.

The ECB is tasked with setting monetary policy to keep price inflation just below 2pc.

And the core rate, which excludes energy, food, alcohol and tobacco, fell to an all-time low of 0.7pc.

That may increase concerns that the eurozone may face a period of deflation, a protracted fall in prices that chokes off consumer spending and business investment.

Juliet Tennent, an economist with Goodbody Stockbrokers, said low inflation would be a worry for the ECB.

“The latest inflation figures leave the door open for further action from the ECB, either a cut in the benchmark rate or a cut in the deposit rate,” she said.

Economist with KBC Bank in Dublin, Austin Hughes, said there was now a threat of deflation, a situation that was economically damaging because prices would keep falling.

November’s cut in the ECB rate to 0.25pc does not leave much room to cut the benchmark rate again. But Mr Hughes said the eurozone bank could reduce its rate to 0.10pc.

A reduction in the ECB rate to this level would bring down the repayments on €100,000 of typical tracker mortgage borrowings by €7 a month.

Over a year, a family with a €200,000 tracker would save €168.

Under tracker contracts, each change in the ECB rate has to be passed on to those with these mortgages.

And mortgage experts said it would be difficult for banks to increase variable rates if there was another ECB reduction as the gap between tracker and variable rates has widened to more than €400 a month.

A family with a €250,000 tracker mortgage over 25 years saw monthly repayments fall to €970 after November’s cut, assuming the tracker is set at 1pc above the ECB rate.

If a family had the same sized mortgage on a typical variable rate, they would be repaying €1,375 a month.

Charlie Weston Personal Finance Editor

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