The key chart
Trends in policy rate and composite cost of mortgage borrowing (Source: ECB; CMMP)
The key message
What do recent trends in the cost of euro area (EA) mortgages tell us about the transmission mechanism of ECB monetary policy?
Current ECB monetary policy is notable for both the speed and the scale of the (belated) response. Policy rates have risen 350bp since 27 July 2022, faster than in previous cycles. The speed of the transmission mechanism on the cost of new mortgages – 127bp over the same period – has been equally notable; exceeding the 123bp rise recorded over 32 months between December 2005 and July 2008. Banks and borrowers have had little time to adjust.
The speed of transmission has varied widely, however, even among the EA’s five largest mortgage markets. The cost of borrowing has increased by 174bp and 161bp in Spain and Italy respectively, for example, but by only 100bp in France.
The speed of the transmission mechanism on the cost of new mortgages bears little relationship with either the structure of loans (e.g. variable rate versus fixed rate) or the cost of borrowing at the start of the period. This suggests that country- and industry-specific factors e.g. the level of competition or central bank restrictions (as in the case of France) may be more important, in the short term.
There is a much closer relationship, however, between the speed of the transmission mechanism on the cost of borrowing on the outstanding stock of mortgages and loan characteristics. Some of the largest increases here have occurred in Estonia, Lithuania, Latvia and Finland – markets where the share of variable rate loans exceed 90% – while some of the smallest increases have occurred in the Netherlands, Germany and France – markets where the share is less than 25%.
In Spain, the EA’s fourth largest mortgage market, the share of variable rate mortgages has fallen from over 90% to 25%, in-line with the EA average. Despite this, the cost of borrowing for new and outstanding mortgages has risen faster than the EA average during the current hiking phase. This has led to political pressure domestically and questions for the ECB. The minority party in the coalition government is calling for a cap on the rates on variable loans, while the ECB considers this a matter between the banks and borrowers. Either way, seven consecutive months of net repayments since August 2022 and two consecutive months of negative YoY growth rates may be more significant.
In short, the transmission of monetary policy rates to mortgage rates (the largest segment of EA private sector credit) is both rapid and variable. Banks and borrowers have had little time to adjust to the scale and pace of current tightening. Country-and industry-specific factors are key in determining the speed of transmission on new lending. Loan characteristics are key in determining the speed of transmission on outstanding mortgages and banks’ net interest margins.
Passing through!
The current ECB policy response
Current ECB monetary policy is notable for both the speed and the scale of the (belated) response. Policy rates have risen 350bp in the space of only eight months. For context, in the last sustained period of monetary tightening between 6 December 2005 and 9 July 2008, the policy rate rose 225bp in the space of 32 months (see chart below).
Trends in ECB policy rate (%) (Source: ECB; CMMP)
The transmission mechanism – the background
The transmission mechanism of ECB monetary policy – the process through which monetary policy decisions affect the EA’s economies in general and the price level in particular – is characterised typically by long, variable and uncertain time lags. This makes predicting the precise effect of policy decisions difficult. Two factors to note:
- Changes in the ECB’s monetary stance typically affect lending rates for new loans quickly (see below). However, more time may be needed to impact lending rates for banks outstanding loan portfolios.
- Different loan characteristics also have a substantial impact on the speed of the transmission mechanism at the country level. These include the type of loans (variable rate versus fixed rate), the frequency of revision rates and loan maturities.
Share of variable rate mortgages (% total mortgages) over past 20 years (Source: ECB; CMMP)
There has been a shift away from variable rate mortgages since the GFC, which has only be reversed relatively recently (see chart above). Variable rate mortgages accounted for 59% of total mortgage in November 2004. This share fell to only 13% in January 2017 and stayed around this level until March last year. Since then, there has been a shift back towards variable rate mortgages. This peaked at 25% in December 2023, however, before falling back slightly to 24% in February 2024.
Loan characteristics by country (February 2023) (Source: ECB; CMMP)
As always, aggregate EA figures mask very different market structures across the EA. The share of variable rate mortgages in total new mortgages ranges from over 90% in Finland, Lithuania, Estonia and Latvia to only 4% in France, for example. Within the five EA economies that account for 85% of the region’s mortgages, this range extends from 46% in Italy to 4% in France.
Note that changes in ST rates typically have a great impact on net interest margins in countries and sectors that are characterised by floating rate lending.
The transmission mechanism in practice
Trends in policy rate and composite cost of mortgage borrowing (Source: ECB; CMMP)
Recent policy has had an immediate impact, especially (as expected) on the cost on new mortgages. The chart above illustrates trends in the policy rate (MRR) and the interest rate on new mortgage loans and outstanding mortgage loans with a maturity over five years. As can be seen, the rate on new mortgage loans (the blue line) reacts much faster than the rate on outstanding mortgage loans (the maroon line) to changes in the policy rate (the black line).
At the aggregate EA level, the cost of new mortgages has increase 127bp from 1.97% to 3.24%. This is a bigger increase than the 123bp recorded in the previous hiking cycle between December 2005 and July 2008. The cost of outstanding mortgages has increased 41bp, from 1.63% to 2.04%.
Change in CCOB (in ppt) since June 2022 (Source: ECB; CMMP)
The composite cost of new mortgages has risen 127bp since June 2022, from 1.97% to 3.24%. At the country level, the rise in the CCOB indicator has ranged widely from over 200bp in Estonia (276bp), Lithuania (275bn), Latvia (247bp), Slovakia (211bp) and Portugal (206bp) to less than 100bp in Greece (76bp), Ireland (25bp) and Malta (25bp). Among the largest five EA mortgage markets, the change has ranged from 174bp and 161bp in Spain and Italy respectively to only 119bp and 100bp in Germany and France respectively (see chart above).
Composite cost of new mortgages (%) as at end February 2023 (Source: ECB; CMMP)
The cost of new mortgages also varies widely between the five largest mortgage markets. The range extends from 3.79% and 3.76% in Italy and Germany respectively to only 2.35% in France (see chart above). France has the lowest composite cost of borrowing in the EA. Note that in addition to their relatively high exposure to fixed rate mortgages, French banks are also constrained by a limit, set by the Banque de France, on the amount they can charge for mortgages.
The speed of transmission
Change in CCOB for new mortgages plotted against loan characteristic (Source: ECB; CMMP)
The speed of the transmission mechanism on the cost of new mortgages bears little relationship with either the structure of loans (see chart above) or the cost of borrowing at the start of the period (see chart below). This suggests that country- and industry-specific factors (eg, the level of competition) may be more important, in the short term.
Change in CCOB for new mortgages plotted against CCOB in June 2022 (Source: ECB; CMMP)
There is a much closer relationship, however, between the speed of the transmission mechanism on the cost of borrowing on the outstanding stock of mortgages and loan characteristics (see chart below). These characteristics include not only the loan structure but also the frequency of revision rates and loan maturities.
Change in CCOB for outstanding mortgages plotted against loan characteristic (Source: ECB; CMMP)
In this case, some of the largest increases have occurred in Estonia, Lithuania, Latvia and Finland – markets where the share of variable rate loans exceed 90% – while some of the smallest increases have occurred in the Netherlands, Germany and France – markets where the share of variable loans is less than 25%.
What is happening in Spain?
Trends in EA and Spanish loan characteristics over past twenty years (Source: ECB; CMMP)
Spain is the EA’s fourth largest mortgage market after Germany, France and the Netherlands. The share of variable loans in Spain has fallen from over 90% (pre- and during the GFC) to 25%, in-line with the EA average.
Monthly trends in CCOB for new mortgages in EA and Spain (%) (Source: ECB; CMMP)
Despite this, the cost of borrowing for new and outstanding mortgages has risen faster than the EA average during the current hiking phase. Between June 2022 and February 2023, the cost of new mortgages in Spain increased 174bp from a below EA average 1.69% to an above EA average of 3.43% (see chart above).
Trends in ECB policy rate and composite cost of outstanding Spanish mortgage borrowing (Source: ECB; CMMP)
More importantly for domestic Spanish banks, the rates on outstanding mortgages have risen 129bp since June 2022, from a below EA average of 1.23% to an above EA average of 2.38% (see chart above).This has led to political pressure domestically and on the ECB. The minority party in the coalition government is calling for a cap on the rates on variable loans, for example.
“I’m sure that banks are ready to negotiate in order to ease the burden on households over time. It is in the banks’ interest to do so.”
ECB President Lagarde, 5 March 2023
In a 5 March 2023 interview with “El Correo”, ECB President Lagarde was asked: (1) if she had a comment for Spanish families suffering from higher rates; (2) if she thought that caps were feasible; and (3) whether Spanish banks should remunerate customer deposits. Perhaps unsurprisingly, Madame Lagarde, argued that these issues were determined by the relationship between borrowers and lenders.
Trends in Spanish monthly mortgage flows (EUR bn) (Source: ECB; CMMP)
In this context, a more telling response comes from industry dynamics instead. Spain has experienced seven consecutive months of net repayments since August 2022 (see chart above) and two consecutive months of negative YoY growth rates (see graph below).
Trends in annual growth rates in mortgages for EA’s five largest markets (Source: ECB; CMMP)
Conclusion
The transmission of monetary policy rates to mortgage rates (the largest segment of EA private sector credit) is both rapid and variable. Banks and borrowers have had little time to adjust to the scale and pace of current tightening. Country-and industry-specific factors are key in determining the speed of transmission on new lending. Loan characteristics are key in determining the speed of transmission on outstanding mortgages and banks’ net interest margins.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.