What could be more damaging to the Irish economy — Brexit or the European Central Bank (ECB)?
This may seem an odd question, not least because we have been fretting about Brexit for a year now and have hardly heard a dickey bird from the ECB in ages.
But think about it, we don’t know how Brexit will affect us, particularly now as the Brits themselves don’t seem to know what type of Brexit they want, let alone what type of Brexit they are likely to get. But when it comes to interest rates, we can be under no doubt.
Any increases in interest rates could have a significant impact on Irish balance sheets because we are still a highly leveraged society.
It is with this in mind that the statement from Mario Draghi this week might be a cause for some concern. On Tuesday, the ECB president declared that “deflationary forces have been replaced by reflationary ones”.
The medium-term implication of this is that European rates might have to rise.
Personally, I don’t think they will rise by much, particularly as the Italian banking system is in a state of perilous fragility. But that said, the continental economy is beginning to emerge from a nearly decade-long slump during which the central bank slashed interest rates to avoid ubiquitous insolvency.
Now that the patient is convalescing, there may be higher inflation on the way — at least that’s what the ECB boss is warning us about.
Now, to assess what a rate rise or a series of them would do to the Irish balance sheet, we need to dig a bit. Forgive me if today’s article is a bit heavy on the numbers, but we need to crunch those numbers a bit to see what might happen.
The first thing we see when we look at the balance sheet is just how much debt Irish people have paid back over the past few years. The numbers are enormous and the comparison with the continental position is staggering.
In fact, they are so big that I suspect we may not be so much paying down debt as not paying it at all.
My hunch is that some of these figures reflect mass default that has gone on under the counter with banks doing deals with those canny enough to strike them or the banks simply being left with properties and loans that aren’t serviced at all. But nonetheless the figures are startling.
According to the latest national quarterly accounts, Irish households have reduced debt as a proportion of income more than any country in the European Union over the past four years, but we still remain the fourth most indebted in the EU.
Irish household debt has fallen from 194% of disposable income to 141% from Q4 2012 to Q4 2016.
This is an extraordinary achievement. It’s a decline of 52.9%.
Consider that the equivalent figure among other European countries is a tiny decline, just 3.3%. So Irish households have been paying back debt 18 times faster than our EU neighbours.
This is mass deleveraging on a monumental scale.
Clearly when you are paying back debt, you are not spending. Therefore, if many of us are not spending, who is? Someone is! If this were not the case, the economy would be contracting at great depression rates, but it’s not. In fact, the economy is growing rapidly.
This paradox means that the people who didn’t have debts are spending like crazy or those with debts are paying back and spending like mad. (Leave this conundrum with me, as I’ll come back to this oddity next week).
For now, let’s keep our eyes on the interest rate dilemma. Despite the massive recent effort to pay down debts, lots of Irish people are also borrowing again. And we are borrowing for housing, yet again.
Check out these figures for the first three months of this year. We are at it again but maybe we are being a bit more careful. Principal dwelling house (PDH) fixed-rate loans recorded a net increase of €615m over the quarter.
This means punters are getting worried about higher rates because floating-rate mortgages declined in net terms by €522m during Q1 2017.
There were declines across all categories including tracker mortgages (€384m) and standard variable-rate mortgages (€124m) which account for 39% and 43% of PDH mortgages respectively.
This means that punters are switching and trying to lock in today’s low rates for fear that rates will rise.
But still the overall picture is one of a society heavily in debt.
Household debt stood at €143.8bn in Q4 2016. Per capita, household debt stood at €30,199. But the big picture is one of a country still suffering the hangover of the boom. Household debt has declined every quarter since its peak of €203.7bn in Q3 2008 and has fallen by 29% since then.
Now let’s talk about interest rates and imagine what might happen if they were to go up.
As of Q1 2017, the average standard variable rate being serviced on was 3.75%.
This is down from 3.94% a year ago. This is a scandal given that banks are borrowing for free from the ECB and charging you the guts of 4%. The average rate on outstanding trackers is 1.03%.
Now imagine a 1% increase in the ECB rate.
Because rates are historically low, a relatively small 1% rise would have a big absolute effect.
A 1% increase on a variable rate of 4% would imply a 20% real increase from 4% to 5%.
For trackers, moving from 1% to 2% means that the borrower would experience a doubling in rates paid.
With the country still heavily indebted, it’s not difficult to see how the ECB is a more immediate threat to prosperity than Brexit, but you’d never think that listening to all the chatter that’s clogging the airwaves.