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The big picture (continued)

04 September 2015
Richard Kemmish

Covered bonds probably aren’t an instrument for policy makers to control the demand for housing. Although the ECB’s purchase programme is doing precisely that in practice, as I mentioned in my previous post.

But low interest rates are about stimulating the more depressed economies of the Eurozone. Globally QE still feels like an experiment. Despite the attempts of many central banks to use the tool it is safe to say that we still don’t really understand the relationship between QE and growth, or QE and inflation.

One discussion that I was involved in at the Euromoney Covered Bond Congress in Barcelona was about precisely this. In particular, how can you explain the very different responses of Eurozone countries to the ECB’s measures – with Ireland as the obvious poster child for the supporters of zero interest rates. It worked there far better than it did in other jurisdictions, growth returned to Ireland long before it did to other depressed economies.

For me it seems that there are two possible answers (they don’t contradict and both are probably partially true). The less interesting one was structural reform – simply that the Irish banking industry was culturally better at recognising and addressing NPLs on their balance sheet than most, freeing up its ability to start channelling funds back into the economy.
But the answer which intrigues me most, and which is more relevant to our topic, is simply that most mortgages in Ireland are floating rate. Therefore interest rate changes very rapidly flow through to spending power of the personal sector, and therefore to the economy as a whole. There is a fairly strong correlation between speed of recovery in response to monetary policy and average duration of retail mortgages.

Which is odd given how many people advocate fixed rate mortgages to improve creditworthiness of the product. I spoke to one person at the conference, from a country with no fixed rate mortgages and no covered bond market yet, who said that she hoped that the introduction of covered bonds will help to stimulate the fixed rate mortgage market in her country.

Another delegate at the conference said that the development of long term fixed rate mortgages was, if not a pre-requisite then certainly a positive encouragement for the development of a covered bond market. I, and the many, many countries with large covered bonds and low duration or floating rate mortgages, beg to differ.

Are long term fixed rate mortgages even more credit-worthy  - by protecting home-owners from payment shocks in a rising rate environment – as their supporters claim? Maybe we are about to find out when euro rates finally rise. But I think that drastic rate rises and the increased mortgage credit problems that they cause are usually concerned with attempts to peg foreign exchange rates (remember sterling trying to stay in the ERM?).

The policy response to a depressed economy – and therefore a rising risk of mortgage arrears – is to cut rates. Clearly this is likely to reduce arrears in a predominately floating rate environment.

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