Higher interest rates are less of a problem than an overall rise in the cost of living says Madis Müller

High inflation becomes persistent in an economy if it becomes entrenched in the expectations of people and businesses and in their wage demands and price setting. This can then pose a danger to competitiveness and jobs in the economy in the longer term. Governor of Eesti Pank Madis Müller explained that the change of course in the monetary policy of central banks is intended to head off just such a threat.

"Getting inflation under control is of primary importance, and the main way that central banks can do that in unfortunately by raising interest rates", he noted at a public seminar today at Eesti Pank on how higher interest rates affect the financing of the Estonian economy and how people and companies cope with it.

The European Central Bank has raised interest rates in the euro area on seven occasions since last July, increasing them by a total of 3.75 percentage points. The central bank has also tightened monetary policy by limiting its purchases of securities and reducing its balance sheet.

Mr Müller admitted that higher interest rates have increased loan repayments for many Estonian families and pushed them to tighten their spending on other things. "Comparing the impact that higher interest rates have on borrowers with the amount of the family budget that is consumed by double-digit inflation shows though that although rising interest rates are troubling for borrowers, the general rise in the cost of living is a larger problem", he said.

Some 150,000 households in Estonia, or almost a quarter of the total, have a housing loan. The average amount outstanding on those loans is 50,000 euros. Calculations by Eesti Pank show that Euribor rising from zero to its current level of 3.6-3.7% adds around 100 euros to the monthly loan repayments of those households, which is 4% of their net income. There are few families whose loan payments have increased by more than 300 euros, and the incomes of the families that have taken a loan are generally notably higher than the Estonia average.

The calculations by Eesti Pank show the interest costs for businesses next year will be double what they were last year, averaging 10% of profits. Companies should be able to afford this given the profits they have earned in recent years.

"We do not currently see businesses and households having major problems with their capacity to service their debts", said Mr Müller. He commented that the volume of bad loans could increase if the economy deteriorated, but that the proportion of such loans would remain small.

"Eesti Pank believes it is important that the interest rates that banks pay on deposits rise together with lending rates", he added. "This has already happened, as the average interest rate on corporate term deposits rose to 2.3% in April, and the rate for households rose to 2.5%. The interest rate on term deposits of one year has already reached 4% at some banks".

When interest rates will stop rising depends on the overall performance of the euro area economy and the developments in inflation. High energy prices have already passed into other prices, and high inflation has boosted growth in wages. The fiscal policies of European governments are also continuing to fuel economic activity and inflation, and this does not make the task of the central bank easier. Inflation was 7% in the euro area in April, and in Estonia it was 13.5% on an annual basis.

"We do not directly forecast interest rates at Eesti Pank or at the European Central Bank", Mr Müller explained. "Given how high inflation currently is though, I think it is highly probable that we can expect more than one further rise of 0.25% in interest rates. It is probably also too optimistic to expect interest rates to start falling early next year".

The forecast published in March by the European Central Bank expects that inflation will fall to close to 2% in 2025.

Additional information:
Hanna Jürgenson
Eesti Pank
Tel: 56920930
Press enquiries: [email protected]

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