Economist: Monthly mortgage payments could rise by 10-20% in Latvia – Baltic News Network

Over the past 12 months, consumer prices in Europe have risen at a pace not seen in the eight years before the pandemic. This forces the European Central Bank (ECB) to find ways to combat inflation never seen in the history of the monetary union.

How aggressive are the ECB’s plans to fight inflation, and will Latvian residents be forced to pay more for their mortgages as a result of these plans?

Since 2012 and until the start of the Covid-19 pandemic, the inhabitants of the euro zone have become accustomed to living without perceptible inflation. It was during this period – eight years – that consumer prices increased by almost 9%. That’s almost as much as the rise in inflation over the past 12 years. The increase in consumer prices observed in May exceeded 8%, setting a new record in the history of the monetary union. May inflation in Germany was the highest since the 1970s, comments Simona Striževska, economist at CBL Asset Management.

Although the prices of energy and food resources remain the main driver of inflation in euro area member states, price increases have become faster in other categories of goods and services. Inflation as a phenomenon is rooted in the economy and in people’s minds. If left unchecked, this creates risks of higher inflation and lower quality of life in the future.

Over the past decade, the ECB has become accustomed to managing low, not high, inflation. This is why the institution ignored the threat of inflation until the last moment. The start of the war in Ukraine and the surge in resource prices have increased post-pandemic inflationary pressure. This forced the ECB to turn to a restrictive monetary policy. To combat record inflation, the ECB has started to prepare the ground for the first rate hike in more than a decade despite the expected slowdown in the economy in the region, Striževska says.

According to reports from ECB officials, the first two euro rate hikes could take place in June and September. This could end the era of negative rates in the eurozone. Alongside the ECB’s base rates, other rates will rise, directly affecting private borrowers in the monetary union, including Euribor – the interbank interest rate that makes up the variable part of many loans. Loans will become more expensive, limiting demand and inflation in the process. Even now, governments have to pay more to borrow money from financial markets.

Generally, more than half of the loans issued by commercial banks already include the variable part, which depends directly on the orientation of the monetary policy of the ECB. However, for mortgage loans, such a ratio in the euro area is much lower. On top of that, in recent months it has accounted for no more than 15-20% of new loans issued. The situation is different in the Nordic and Baltic states of the euro zone, as well as in Finland – most mortgage loans include the variable part. If the Euribor rate turns positive, loan servicing costs may increase not only for new mortgage users, but also for those who are already in place.

While the Euribor rate has remained in the negative zone since 2015, there was no need to pay attention to the variable part of the loans. It was close to zero. If the Euribor rate increases by o 1%, the monthly mortgage repayments for loans with a remaining term of around 20 years can increase by 10% on average. Repayments for loans with ten years remaining can increase by an average of 5%.

With the ECB’s transparent deposit rate hitting 0% versus -0.5% currently, the ECB’s monetary trajectory so far remains uncertain. The ECB may not stop at what it has achieved so far. Members of the financial market predict that the ECB will continue to raise rates. The 3-month Euribor rate could approach 1% by the end of the year and stabilize between 1.5% and 2.0% over the next two years.

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