Bill Tyson on the inexorable rise of the euro

The euro rose to a two-year high this week – bringing with it some good and bad news

The euro is on a roll. It rose this week to almost 90p sterling as the European Central Bank (ECB) signalled the end of the era of extraordinarily low interest rates. But what does this mean for your mortgage – and your savings and investments?

It could even impact on your holiday plans if you visit a non-eurozone country like the US or Britain. Across the board, there’s both good and bad news. But firstly, there’s no need to panic. The bottom of the interest rate cycle was a long time coming and markets have come to terms with it.

Nonetheless, it is currently giving a sustained boost to the euro.

The resurgent currency this week reached its highest level since January 2015.

Almost touching 90p sterling on Friday, the currency is the strongest performer of the world’s top ten monetary units so far this year.

This is in stark contrast to the euro’s usual role in recent years as the ‘whipping boy’ of foreign exchange markets, thanks to ECB boss Mario Draghi’s traditionally soft monetary policies.

For six years, Draghi kept the bank’s interest rates rock bottom, even negative in some cases, which depresses the value of the currency by encouraging investors to shift their money elsewhere for higher rates. He also devised a plan to basically print and distribute over a trillion euro in a bid to stimulate the eurozone economy in what is called Quantitative Easing (QE)

This also depresses the currency’s value but is good for exports, which stimulates job creation.

But the main job of Central Banks is to contain inflation. And now Mr Draghi is starting to be more worried about this factor than he is about the economy in general. He sent out strong signals this week that his largesse is coming to an end.

This has encouraged markets to strongly back a continued rise in the euro, as sterling continues to falter with the shadow of Brexit hanging over it.

‘It’s an armour-plated rally (of the euro) and it won’t stop,’ Peter Kinsella, a London-based senior foreign exchange and rates strategist at Commonwealth Bank of Australia, wrote in a note.

‘Everything speaks in favour of further EUR appreciation – increasing portfolio inflows, changing monetary policy, improved political risks,’ Mr Kinsella added. Political clouds

loomed over the eurozone early this year with fears that extremist candidates could win elections in France and Holland, derailing the euro and even threatening the EU itself.

But these fears proved so far unfounded with the resounding French presidential election victory for Macron over Europhobic Marine Le Pen in particular helping to reassure markets that the EU wasn’t headed for a meltdown.

‘The economy is going well and the political situation is now benign when there were major worries hanging over the eurozone,’ said Alan McQuaid, economist with Merrion Capital.

However, he warned that political uncertainty in the eurozone could re-emerge again next year with an Italian election looming in May.

‘That could potentially be seen as the end of the euro if the wrong party got in. But as things stand over the next 12 months, it looks relatively stable,’ Mr McQuaid said.

He predicts that over that period, the euro will rise to $1.20 level against the dollar and may break 90p sterling in the short term.

However, he reckons it will finish the year in the 85p-88p range as Britain will accept the need for a soft Brexit, or even a transition period where it remains part of the European Economic Area with free trade and movement of goods and people for a number of years.

However, even 85p is a lot higher than the 70p sterling rate the euro reached in 2015.

‘That (the current rate) is not good for exports, agriculture and tourism,’ Mr McQuaid warned. ‘Tourism has done well with more American visitors offsetting the fall in British tourists, but as the dollar weakens, this won’t continue. It is good news if travelling to the UK or New York, however.’

So now’s the time to plan a visit to relatives across the Atlantic or Irish Sea – or even to head north across the border for a bit of sightseeing and shopping. Of course, there is a downside to all this.

The euro’s rally is driven by expectations of a 10 basis point rate hike in interest rates (one tenth of 1%) by September 2018.

But there’s no need for mortgage holders to panic just yet, said Mr McQuaid.

A key ECB money rate is currently negative to the tune of 40 basis points.

‘Even after that (10 point) increase, it would still be negative. The ECB would still be charging the banks to leave money on deposit,’ he said.

A ten-point increase in ECB rates may not be enough to trigger a general mortgage hike here, where interest rates are higher than elsewhere, but it would mark the bottom of the extremely low interest rate cycle and further hikes could follow, which would be passed on eventually.

It might be worth looking at fixing your mortgage if you are switching or buying a new home. Fixed rates are in many cases lower than variable rates, especially at Bank of Ireland, which offers an attractive 2%3% cashback deal but has high variable rates (see table).

However, fixing also has serious downsides as you may have to pay penalties to redeem your home loan if you decide to move house.

Also watch out for the interest rate the loan reverts to after the fixed period is up.

The variable rate is the rate the loan reverts to when the fixed rate period is up. Repayments are based on a €200,000 home loan on a property worth €280,000, i.e. a loan-to-value ratio of less than 80%.

The prospect of a one-tenth of a percent increase in interest rates, will do little to cheer savers, even if it were passed on to them, which seems unlikely.

The best bank deposit rate is PTSB’s 0.9% over three years.

But to get that rate you have to salt your money away for quite a while. And when Deposit Interest Retention Tax is deducted you won’t show much in the way of a gain.

The resurgent euro is also bad news for investors and European shares fell on Thursday after Mario Draghi’s hawkish remarks on interest rates and QE.

A stronger currency makes it harder for eurozone-based companies to compete with US and UK firms and is seen as a negative for EU shares.