Interest rates will rise, and we cannot buy our way out of that

The fact that Ireland’s public finances have proved resilient in recent years has not been due to public spending restraint and there has been no appetite for additional public sector taxes or levies.

Corporate tax revenues are well above expectations, but their future development is uncertain. In the meantime, government spending on debt servicing has declined despite the additional borrowing, thanks to the loose monetary policy of the central bank in Frankfurt.

The recovery from the Covid downturn gained momentum in the middle of last year as central banks prepared to end the loose monetary policy that had kept interest rates low. This has always been in sight and the tightening phase has begun in earnest.

In the more indebted eurozone countries, the cost of 10-year borrowing rose last week to its highest level in several years. The US Treasury bond market yield has topped the 3 percent mark and the Irish government would pay around 1.7 percent for 10-year money tomorrow, a figure that was briefly negative last summer. Hogan spoke the same week that official short-term interest rates have been raised in both the UK and US and the European Central Bank is expected to do the same later this year.

Watch Italy, whose government bond market is the largest in Europe, reflecting the legacy of high government borrowing in the past. Italy narrowly avoided an official bailout from the IMF and eurozone institutions after the 2010 debt crisis that hit Greece, Ireland and Portugal.

Greece defaulted, while Ireland and Portugal endured three years of tight budgets under the Troika’s eye. The Italian government would pay 2 percent a year more than Germany to borrow 10-year money tomorrow, and this widening yield differential reflects market skepticism about Italy’s ability to rein in borrowing.

As long as the European Central Bank remains a willing buyer of government bonds (printing money to keep interest rates low), governments can run budget deficits without worrying too much about the market.

Once the ECB leaves the field, governments will have to find voluntary lenders and Ireland is not well positioned. In Dublin last week for regular review, the IMF team criticized the narrow tax base, in particular the low income from home ownership taxes and the abundance of preferential tax rates. They also noted upward pressure on government spending and reiterated the Fiscal Advisory Board’s repeated warnings.

In recent months, the government has given way to calls to offset rising energy costs with tax cuts, and ministers have hinted at further action, including pay rises for public servants.

It is not possible in an open economy to compensate everyone for an increase in the cost of imported energy. It is also not possible to protect homeowners and other borrowers from a rise in interest rates. Allied Irish Bank, in its statement to its annual general meeting, forecast that interest income will improve as the ECB hikes rates later this year and there are already signs that mortgage rates have started to move higher.

Opposition politicians will soon find that “stressed families” dislike higher monthly payments just as they hate paying more at the pump.

But the source of higher interest costs, for both governments and consumers, is entirely external, as is the rise in energy costs. The government has no more control than the price of coffee.

There will be calls for measures to offset higher interest costs and these should be resisted. It’s hard to imagine a more irresponsible policy response than mortgage rate subsidies, which add to the list of demand stimuli already on offer in a supply-constrained housing market.

In the mid-1970s, after the first major oil shock and the Arab countries’ export embargo, the Irish government responded to the surge in inflation with blanket consumer subsidies at high government expense. Policies failed to stem inflation as Ireland had a fixed exchange rate and inflation was beyond the country’s control. It now has no currency at all and no domestic levers of monetary policy.

The general level of interest rates in Ireland can only follow the trend set in the euro zone and determined by the ECB in Frankfurt.

No timeline for rate hikes was set at its last monetary policy meeting on April 14, and the ECB is slower to tighten than its counterparts elsewhere.

He meets again on June 9th in the Netherlands. Plans to phase out government bond purchases are likely to be resolved and official interest rate hikes will eventually occur

The attempt to subsidize consumer prices in the 1970s (there had also been subsidies on mortgage rates) had an inevitable effect, a period of persistent budget deficits that eventually led to the fiscal crisis of the 1980s. With a far greater legacy of sovereign debt, today’s politicians face the same cost-of-living pressures and temptations.

The best guarantee of a government’s ability to respond to external shocks is to maintain an appropriate sovereign debt credit rating. Any proposal for tax cuts or new spending initiatives jeopardizes this outcome, as does opposition to higher retirement ages and water pricing.

The holidays from debt service are coming to an end, higher energy costs could remain and sustainable home remedies are missing. With interest and utility bills, what cannot be cured must be endured.