INTEREST RATES

A report in the Daily Express this week revealed that fixed rate mortgages will cost the average borrower at least £165 a month extra.  Gordon Brown cited housing volatility as a key barrier to euro entry in June in his five tests speech and announced a push towards fixed rate mortgages as an attempt to combat this volatility.  The research in the Daily Express reveals however that fixed rate mortgages are unlikely to be popular.   Simon Tyler of independent adviser Chase de Vere Mortgage Management, said “they  (fixed rate mortgages) are never the cheapest deals on the market, so they will probably never be the most popular” (Daily Express, 18 November)

Gordon Brown is preparing to slap down Mervyn King, the new Governor of the Bank of England , and ignore his concerns over a change to the inflation target ordered as part of the Government's "prepare and decide" policy on the euro. Mr King said on Wednesday, just six weeks into his new job, that he was unhappy about the proposed change and the City is now bracing itself for the most serious row between the Bank and the Treasury for six years. Mr King said changing the target - which is expected in November - would be as if "David Beckham had taken a shot on goal only to see someone had moved the posts". Mr Brown wants to switch from the retail prices index (RPI) to the harmonised index of consumer prices (HICP), a measure which excludes housing costs and is therefore a much easier target to hit, as it generally comes in 0.5pc to 1pc lower. The Governor said leaving out housing costs would be "strange" and might confuse people. There is a risk interest rates could be artificially cut at a time when they are already at a 48-year low and consumers are running up debts at a record pace. A spokesman for the Treasury dismissed Mr King's concerns. He said: "The Government's policy remains as set out by the Chancellor on June 9. (Daily Telegraph 16/08/2003 )

As consumers rush to take advantage of record low interest rates Irish money advisers are warning that an increasing number of people are in danger of being over-whelmed by multiple debt burdens. And last week's 50 basis points cut in the European Central Bank rate threatens to propel Ireland 's private-sector credit levels, which last year reached €l43 billion, to yet more record-breaking heights as incentives to save all but dry up. Over the past 5 years, private-sector debt in Ireland has rocketed. In 1997 the ratio of private credit to GDP was 29.9 %. By the end of last year this had soared to nearly 40%. Economists estimate that 65% of our personal disposable income is consumed by mortgage payments. It is estimated that, with the addition of other loans and credit facilities, personal debt accounts for between 77% and 87% of personal disposal income. What could have the greatest impact is the arrival of deflation, which means the value of money decreases over time. If this happens, real debt repayments will eat even further into disposable income. The risk of deflation increases particularly when interest rates fall against a strengthening euro. (The Irish Times-Business This Week 13 June 2003 )

Firstly, the "basket of goods" that makes up the Harmonised Index of Consumer Prices (HICP) is not the same as that for our own RPI. Most significantly, the RPI includes "housing depreciation", a surrogate for house prices. This has only been in the index since house prices started to recover. If there were another crash - far from impossible - it would pull RPI down, below HICP. Secondly, the statistical method used to process the raw data differs beteween the two indices, in such a way that the HICP is lower than the RPI. The only advantage of the HICP, as far as I can see, is that it enables us to compare like with like when considering inflation across the EEA. For a long time, UK inflation as measured by the HICP was the lowest or amongst the lowest in the EU. We didn't hear so much about it from the enthEUsiasts then. (e-mail J Fox 9/6/03 )  

Every month, we estimate the interest rate that each of the seven largest euro-zone countries would set if left to their own devices, based on their own economic needs. We calculate the "Taylor Rule" for this purpose which expounds that the correct interest rate for an economy can be arithmetically calculated with reference to the economy's inflation rate and the economy's position in the economic cycle. Our calculations suggest that Germany does indeed need an interest rate of around zero per cent, as compared with the eurozone interest rate of 2.5 per cent. Unfortunately for Germany , and indeed for the rest of the eurozone, the German government is powerless to reduce Germany 's interest rate, which is set in Brussels for the eurozone as a whole. Numerica (Letter to the Daily Telegraph London 2 6 03)

The European Central Bank (ECB) might lower its forecasts for eurozone growth once again as its latest forecasts, published only ten weeks ago, are already thought to be out of date, writes the Financial Times. Last week the ECB kept its interest rates steady at 2.75 per cent due to political tension over possible war in Iraq. (11/2/03 EUobserver.com) 

 Mr Duisenberg has come under heavy fire for being too slow to cut rates this year as the world economy struggled to climb out of recession. The ECB finally made a half point cut to 2.75% in November. The eurozone is set for a tepid recovery, he warned in an interview on a Dutch TV station. (Guardian December 30, 2002)

The European Central Bank this week announced that it will review its inflation target. The present target, which states that inflation has to be between zero and two percent, has been attacked as being deflationary, confusing and for not allowing enough flexibility. The emphasis on very low inflation and the lack of flexibility has meant that the ECB has been forced to raise interest rates to levels which are damaging to many Eurozone economies. Economists are increasingly concerned that Germany could be on the brink of a recession and possible deflation. Ernst Welteke, the President of the Bundesbank, said this week that Germany, "would possibly have lower interest rates" if it were not a member of the euro (Bloomberg, 17 December). However, ECB Vice-President Lucas Papademos, at a speech in London this week, quashed hopes of any major reform. Papademos said that "ideas to change the ECB's inflation objective are not acceptable". This was backed up by comments from Eugenio Domingo Solans, Executive Board Member of the ECB, who said that "economic growth shouldn't be considered an objective for the euro-system's monetary policy" (Bloomberg, 16 December).

The ECB did not set 2 per cent as a target, in the sense that 2.5 per cent is a target in the UK. It is an upper ceiling, with the implication that policy should aim as near as possible at zero inflation. Average prices of non-energy industrial goods have kept comfortably within this ceiling. For the past six quarters, however, food prices have risen far faster than the ECB limit, which sounds like more than bad weather. In UK terms, the Eurostat figures also understate inflation. Using the harmonised index of consumer prices, UK inflation has generally been below 1 per cent over this period, even though the Bank of England has from time to time thought it necessary to raise short-term interest rates. In UK terms, euro inflation is probably well over 4 per cent. A conspiracy of silence has been drawn over this price failure in euroland. Since those heady early days, the eurozone economy has become becalmed. Economists argue that the ECB was slow to cut interests rates. If it considered putting them up any time soon, recovery would be nipped in the bud. Maybe so. The conclusion must be that the eurozone is not yet capable of sustaining reasonable growth without running into inflation at rates previously considered unacceptable. That is a chilling message for those who want the euro¹s exchange rate against sterling to rise fast and soon. (The Times 03 Apr 2002)

BANK of England interest rate cuts and the move to slash the cost of lending by leading banks and building societies have resulted in mortgage deals in Britain being cheaper than in many major countries in the European Union. The Government has argued that one advantage of Britain joining the EU would be lower interest rates and correspondingly lower mortgage payments. However, new figures from the European Mortgage Federation suggest that this is not the case. UK lenders have long argued that the mortgage market here is so much more competitive than in Europe - that borrowers already get deals at least as good as they would on the Continent. Although the European Central Bank's lending rate is 4.75pc compared with the 5.5pc set by the Bank of England, British borrowers get better mortgage deals than anywhere except Spain and Ireland. Standard mortgage rates in Europe 2001:

(Daily Telegraph 14/4/01)

Danish interest rates fell below that of Euroland at the end of March, exactly six months after the Danish referendum on membership of the euro, where the largest Danish bank, Danske Bank, together with the Government, attempted to scare the Danes with threats of higher interest rates. According to Danish daily Politiken on Tuesday, the average euro interest is now higher than that of Denmark, and the gap between the Danish and the German interest has now narrowed down to 0.25 per cent. "Things turn out exactly as predicted by the Danish "wise men" in their report of May 2000, which said that a No to the euro might lead to lower interest rates," says Drude Dahlerup, spokeswoman for the June Movement. She adds that the Danish Government did everything in their power to discredit the "wise men" and owe them an apology. (EUobserver.com 4/4/01)

It is less than a month since the Danes ignored the dire warnings of economic meltdown from their political and financial masters and voted not to join the euro. Their central bank immediately punished them for their impudence by raising interest rates. Yesterday, for the second time, it trimmed money costs to prevent the krone from bursting out of its ERM range. (D Telegraph 27 October 2000)

The economic costs of UK membership of European Economic and Monetary Union (EMU) could be as much as £9 billion a year, research published by the Bank of England has suggested. A working paper co-authored by a Bank economist has estimated that the damage inflicted on the UK by the loss of sovereignty over interest rate decisions could be equivalent to more than 1 per cent of national income every year. (The Times, 5 November 1999)

There has been a significant shift in the bond and futures markets reflecting a growing belief that we are unlikely to join the euro in 2001. Whilst yields have risen in the 4 - 7 year range, the yield on 30-year UK interest rates is only 4.7%, well below the German equivalent of c. 5.5%. This is a sign of confidence that Britain has abandoned the boom-bust cycle, and is further evidence that there is no need to join the euro to have "stability". (Business for Sterling briefing 18/7/99)

THE chairmen of Selfridges, Next, Weetabix and Somerfield have joined the ranks of prominent business leaders backing the campaign to save the pound. They are among a list of about 130 supporters to be unveiled this week by Business for Sterling, the anti-euro campaign, in a move designed to weaken the Europhile claims that commerce and the City want to scrap the pound. (The Daily Telegraph, 18/01/00.)

Euro-zone countries would have to accept higher interest rates as the price for UK membership of the European economic and monetary union. Countries suffering from slower growth, such as Germany in Italy, could be held back by the European Central Bank's need to raise rates by as much as one percentage point to accommodate UK entry, the Centre for Economic and Business Research says. The addition of a large flexible economy with relatively high natural interest rates would increase the average interest rate likely to prevail in the whole area. Paradoxically, the UK joining the euro would be good for Spain and Ireland, easing the problems of monetary management caused by excessively low interest rates in those countries. (Financial Times 21 June 1999)

If the UK is to join the Euro it has to end up naturally with the same interest rates as the Euro-zone, a more sensible exchange rate and sustainable convergence of inflation. Only two possibilities suggest themselves. The first would be a vigorous recovery in the Euro-zone, generating both higher short-term interest rates and a strong Euro. The second would be fiscal tightening in the UK. The former would be a favourable act of God. The latter would be an unpopular act of government. Unpopular because to offset the inflation boosting impact of lower interest rates and depreciation, the fiscal tightening would have to be large. It might need to be £20 billion, or 2 1/2% of gross domestic product. The UK Chancellor would then be introducing what amounts to a Euro tax. It would not be designed to meet the Maastricht fiscal criteria, since the UK already does so, but rather to constrain demand with a view to offsetting a domestically unwarranted reduction in interest rates. This would also generate an unnecessarily large fiscal surplus. If the government wanted to lose a referendum campaign on the Euro, one could not imagine a surer way of doing so. The price of eliminating the exchange rate instability that directly affects only 14% of UK gross domestic product could therefore be a monetary policy that de-stabilises the economy as a whole. (Financial Times Martin Wolf 2 June 1999)

The UK government has a daunting wish list if it wants to join up with the euro in 2002. It needs the pound to fall to a rate that will allow UK manufacturers to be competitive on Europe entry. It needs UK interest rates to fall closer to European levels, but not so close that it cannot dangle a mortgage rate cut in front of a euro-sceptical electorate. And the government's power to achieve these probes is virtually zero having ceded interest rate setting power to the Bank of England and exchange rate policy to the markets. Getting the pound in on schedule may prove a lot more difficult, and could be a lot less desirable, than the markets currently think. (Financial Times 7 June 1999)

"The crunch will come in 3-4 years time. We have until then to persuade the City that joining the Euro will be bad for Britain. We have to persuade them that the City has always thrived on being independent and working successfully through global capitalism. Staying out of the Euro will give Britain stability in its economy, which is better than pursuing stability in the markets through monetary union. The single currency would plunge us into boom and bust cycles as inappropriate single interest rate restrictions begin to bite. No one should be in any doubt that British participation in the single currency would destroy the City of London. It has partly been designed to do just that". (Bernard Connolly, the former head of the Commission unit responsible for monitoring and servicing the ERM, CIB meeting 29th March 1999)

It is important to note that the propaganda currently being released by the European political machines touts the Euro as the answer to all ills. In fact, a single currency will NOT create a single interest rate for Europe since that does NOT even exist among the 50 States in America. Each nation state will eventually be treated based upon its own credit risk. The information being presented by the political forces within Europe are touting dreams that make no economic sense as a means to promote the Euro and the federalisation of Europe without ever mentioning that end goal. It is absolutely impossible for Europe to impose a single interest rate upon the whole membership of states. As long as some sovereign rights reside with the individual nations of Europe there will be differences in credit risk as there is today between all 50 states within the US. Therefore, even if the single currency succeeds, speculation will be shifted from currencies to the bond markets. The socialistic dreams of Europe that paint a utopia where everyone will enjoy the same interest rate and stability simply cannot materialise, as has been the case throughout the past. If capital perceives that the French are going in their separate direction from that of Germany, France will find it cannot sell its bonds at the same rate as Germany. France will be forced to sell its bonds at a discount such as 98 to Germany's 100. In effect, Europe will be no different in 2002 than it is today. All that will be saved is mere currency costs of transactions within Europe but not external to Europe. In order to deliver the dreams of European politicians as related to the people, only a federalised Europe with dictatorial powers over domestic policy in each nation can deliver. If this is the ultimate true goal, then devolution in Britain has come at the precise wrong time. What does appear to be clear is that at least short-term interest rates will be federalised. This will not end speculation, but could promote excessive speculation in the bond markets. If France is not following the same economic agenda, then it may find that if short-term rates cannot differ throughout Europe, then it will be forced into shifting its national debt into long-term funding where the market will dictate the interest rates - not Brussels. If each nation retains the right to issue its debt in Euros at will, the system will collapse as surely as it did in the United States pre-1792. (Princeton Economics International)

REAL INTEREST RATES AT NOVEMBER 1998

(Eurofaq posting R Buttrey 30/11/98)

Poor Rates for euro depositors. The future for savers looks bleak if the opening rates for accounts in the new European single currency are anything to go by. Citibank this week started taking applications for its euro savings accounts, although these will not be opened until the currency comes into existence on January 1st. The UK-based euro account will pay just 0.5 per cent interest on £10,000. Even on £60,000 or more, it will pay only 1.25 per cent. The rates are appalling by British standards, where small (sterling) deposits can earn 7 per cent or more. Citibank points out that base rates in the euro-zone are likely to start at 3.3 per cent, less than half that in the UK. The accounts are useful only for regular travellers to Europe or investors renting out property where the rent will be received in euros, as the rate is too small to make it a worthwhile investment. (FT 28/11/98)

One of the biggest doubts about the European single currency was how one interest rate could be appropriate for the 11 countries that joined economic and monetary union. In the long run, it is hoped, cycles will converge. But for now, economies are diverging. There is nothing the European Central Bank can do about this. More worrying, though, there is little hope that the countries themselves will be able to force their economies back into line. The OECD spells out the problem. Germany and Italy, it says, have slowed to well below their potential growth rates. Meanwhile countries including Ireland, Spain and Portugal have excess demand. In theory, with monetary policy controlled centrally, countries should use fiscal policy to find tune their economies. This may not be possible. Ireland, for example, already has a sizeable fiscal surplus, and has promised to cut taxes as part of the wage restraint deal. An alternative is for slower growing countries to run a more expansionary fiscal policy; but they are already too close to the Stability and Growth Pact limits. (Financial Times 19 May 1999)

Interest rates in the future EU could be significantly higher than current national rates. The European Central Bank will try to establish credibility early on. Taking higher inflation into account interest rates under EMU will be about 5.75% compared with the current average of 4.25% in the forward market. (FT4/8/97)

Mortgage lenders moved this week to deny that lower short term interest rates in the Eurozone have led to cheaper mortgages. The European Mortgage Federation (EMF) commented that the average cost of a home loan in Britain is 7 per cent, compared to 6.75 per cent in the Eurozone. The comments followed Tony Blair's assertion that: "It is precisely because I believe it is important for British jobs and British industry and British mortgages that we are in principle in favour of joining [the euro]." (29 June 2000). (BfS briefing www.bfors.com 6/7/00)

The UK has a very high level of household owner occupation. This means interest rates have a strong influence on inflation and demand. In order to help the UK to join the EMU taxes on house sales and property ownership should be raised. The Economic and Social research Council recommends that there should be automatic tax on rises in house values and higher stamp duty. The high level of borrowing and low transaction costs drive the volatility of the market. (Independent 22/11/97). Oxford Economic Forecasting says that high owner-occupation, high indebtedness and the predominance of variable rate mortgages could trigger a boom-bust cycle in house prices under EMU. Their solution is higher income, or council, taxes, subsidies for fixed rate mortgages and a boost for the house building industry. (FT 5/1/98) In the UK mortgage debt is 60% of GDP, in Germany it is 40%, in France 25% and Italy 10%. (The Times 2/6/98). In Europe, however, despite the lower bank rate, mortgages cost much more; in France and Germany they cost twice the bank rate and deposits are around 20-40%. Whereas in May the fixed rate mortgage interest in the UK was 5.89%, in Germany it was 6.7%, France 6.7%, Holland 6.7%, Belgium 6.9%, Italy 7.8% and Denmark 7.1%. (Sun 28/5/98) . "It is a myth that entry will bring cheaper mortgages", said Mike Lazenby, a director of Britain's top building society, the Nationwide. "Our economy is fundamentally different from other European countries. There is nothing to say that joining EMU will push mortgages down to European levels - we could see them rise slightly in the short term". (New Alliance web site August 1998)

Continental European mortgage rates are mainly linked to long-term interest rates, in contrast to the UK. Long-term rates are generally much higher than short-term rates. If Britain were to adopt the Euro, such a shift would be vital. The European Central Bank will not pay the attention to the UK housing market that the Bank of England affords. The fall in interest rates in Ireland has stoked a housing bubble that makes the UK experience in the late 1980s look tame. If the British government does adopt the Euro now well prove to be a good time to buy a house. (Financial Times 5 April 1999)

Mortgages are based on long-term interest rates. The ten-year rates for different countries are as follows:

(Eurofaq 28/2/99) (FFP)