COLM MCGRATH, Managing Director, Surety Bonds, writes that while interest rate hikes are starting to impact some areas of construction, our substantial budget surplus affords Ireland some resilience.
The European Central Bank’s fast track of higher interest rates starts to slow, with an increase of just 0.25% on 04 May a sign that some common sense is beginning to prevail. While there was another .25% increase on 15 June, if there is a slump or potential recession on the horizon, then they may halt further interest rate hikes.
The industrial powerhouse of Europe, Germany, has seen production fall further than expected, mainly driven by the automotive industry (pardon the pun). The decline was sharp, dropping by 3.4% in March on the previous month. According to Reuters: “In March, German industrial orders fell by 10.7% from the previous month on a seasonally can calendar-adjusted basis, posting the largest month-on-month decline since 2020, which was the height of Covid”.
TOO HARD, TOO FAST
While the ECB had to play catch-up, did they go too hard too fast? As I mentioned in my previous article in this publication, the hawks were pushing this agenda without taking time to reflect and allow for the lag effect that previous hikes may have already tapered inflation. The damage may already be done, which will be hard to reverse from a monetary policy perspective and a saving face mindset.
WHAT NEXT?
So where are we at? The increase in rates has a negative impact on borrowing costs for individuals and businesses. As the cost of borrowing rises, it becomes more difficult for individuals and businesses to access credit, which can lead to a slowdown in economic activity. To some degree, this is what the ECB wants, as a slowdown in economic activity leads to a slowdown in inflation. Ultimately, it leads to a decrease in consumer spending, with consumers less likely to borrow for cars or homes, while business will be less inclined to invest in new projects or expansions. The additional downside to higher interest rates is the strengthening of the Euro currency. When interest rates rise, investors flock to Euro-denominated assets such as government bonds. While a strong currency has the benefit of making purchases of goods and services from abroad cheaper, it makes exports more expensive and less competitive. This could have a negative impact on export-driven economies such as Germany and the Netherlands, negatively impacting their growth.
As I have highlighted in the past, an increase in interest rates generally leads to a rise in government borrowing costs. As the ECB continues to raise interest rates, the cost of servicing government debt will also increase, leading to higher deficits and increased pressure on government budgets. This leaves heavily indebted nations open to the debt markets, which leads to more expensive debt or debt that cannot be serviced. In order to service this increase in debt, governments cut spending and increase taxes, further slowing down economies.
CONSTRUCTION PERSPECTIVE
From a construction point of view, and I believe we are beginning to see it within the market, decreases in asset prices, offices, housing and stock, funders have moved to safer asset classes, which are providing acceptable yields, a German Bund 10 Year Yield will provide 2.45%, a safe bet. In Ireland, we have been lucky that we have a budget surplus that is circa €12bn and, over the next four years, could be €65bn in total. This gives the government some leeway to allow it to take a portion of the additional funds and step in to be the project funders where required, particularly in the housing Social and Affordable sector. It does look like Paschal Donoghue’s comments on 10 March that he was going to “Sharpen the focus on NDP project delivery” as part of his departmental remit are coming to fruition.
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