Spanish Mortgage: ECB Cuts Interest Rates Amid Signs of Slowing Inflation and Economic Weakness

On October 17, 2024, at its monetary policy meeting in Ljubljana, the European Central Bank (ECB) Governing Council reduced its three key interest rates by 25 basis points. This move paves the way for lower mortgage borrowing costs across the Eurozone, including in Spain. The rate cuts are a response to an updated inflation outlook, evolving underlying inflation trends, and the effectiveness of monetary policy transmission. The changes will take effect on October 23 and follow two previous 25 basis point reductions in June and September, marking a total decrease of 75 basis points so far this year.

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New ECB Interest Rates (Effective October 23, 2024):

• Deposit Facility: 3.25%
• Main Refinancing Operations (MRO): 3.40%
• Marginal Lending Facility: 3.65%

Impact on Mortgage Borrowing Costs in Spain

A reduction in both the ECB’s Deposit Facility and MRO rates typically leads to a decline in EURIBOR, the benchmark rate used for many mortgages. As EURIBOR trends lower, mortgage costs in Spain generally become more affordable for eligible borrowers. However, this doesn’t necessarily mean that banks will relax their lending criteria.

EURIBOR Update

In September, EURIBOR fell to 2.936%, reflecting a year-on-year decrease of 29% and a month-on-month drop of 7%. With EURIBOR trending downwards, mortgage rates are expected to follow suit, offering cheaper borrowing costs for those applying for a Spanish mortgage. However, it’s important to note that while rates are falling, banks may still maintain stringent lending standards.

Currently, EURIBOR remains below the ECB’s MRO rate, indicating that banks can access cheaper borrowing rates in the interbank market compared to what the central bank offers. This scenario is often a result of ample liquidity or low perceived credit risk, signaling that banks are less dependent on the ECB for funding. It also suggests that the financial system is operating smoothly and reflects a broader trend of accommodative monetary policy.

ECB’s Monetary Policy Highlights:

1. Disinflationary Process on Track: The ECB remains confident in the disinflationary trend, with inflation falling to 1.7% in September, the lowest level since April 2021. While energy prices dropped sharply, food inflation saw a slight uptick. Most measures of underlying inflation have either stabilized or decreased. Inflation is expected to rise temporarily due to base effects before returning to the 2% target next year.
   

   “The incoming information on inflation shows that the disinflationary process is well on track.” – Christine Lagarde

2. Weaker Economic Activity: Economic activity has been weaker than expected, with the manufacturing sector contracting and services growth slowing. Household consumption has fallen despite rising incomes, and businesses are increasing investment only gradually. Housing investment continues to decline, but the labor market remains strong, with unemployment stable at 6.4%.
   

   “The incoming information suggests that economic activity has been somewhat weaker than expected…Businesses are expanding their investment only slowly, while housing investment continues to fall.” – Christine Lagarde

3. Data-Dependent Approach: The ECB reaffirmed its commitment to a data-driven approach, evaluating inflation and the transmission of monetary policy on a meeting-by-meeting basis. The Governing Council emphasized its flexibility, without pre-committing to a specific path for future interest rate adjustments.
   

   “We are not pre-committing to a particular rate path.” – Christine Lagarde

4. Downside Risks to Economic Growth: The ECB acknowledged that risks to economic growth are tilted to the downside. Low consumer and business confidence could hinder the recovery of consumption and investment. Geopolitical risks, including the ongoing conflict in Ukraine and the Middle East, may also disrupt global trade and energy supplies. Additionally, there is concern about the delayed effects of previous monetary policy tightening.
   

   “The risks to economic growth remain tilted to the downside…This could be amplified by sources of geopolitical risk, such as Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East, which could also disrupt energy supplies and global trade.” – Christine Lagarde

5. Fiscal and Structural Policy Support: The ECB stressed the importance of fiscal and structural reforms to boost productivity, competitiveness, and resilience in the Eurozone economy. Such policies are key to raising potential growth and alleviating inflationary pressures in the medium term.
   

   “Fiscal and structural policies should be aimed at making the economy more productive, competitive and resilient. That would help to raise potential growth and reduce price pressures in the medium term.” – Christine Lagarde

Other Notable Points:

• Restrictive Stance Remains: Despite the rate cut, the ECB maintains a restrictive stance on monetary policy and will continue until inflation is firmly on track to meet its 2% target sustainably.
• No Recession Anticipated: While economic activity has slowed, the ECB does not expect a recession in the Eurozone, although Germany’s economic performance remains a concern.
• Geopolitical and Trade Concerns: The ECB flagged ongoing trade tensions and geopolitical uncertainties, including potential U.S. tariffs and the impact of the Middle East conflict on oil prices, as risks to growth and inflation.

Summary:

The ECB’s decision to cut interest rates reflects its confidence in the ongoing disinflationary process, while acknowledging concerns about weakening economic activity. The central bank will continue its data-driven approach, carefully monitoring economic conditions to adjust its monetary policy as necessary.