Bigger repayments likely for Baltic borrowers next year

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Simona Striževska, economist at Citadele Bank subsidiary CBL Asset Management looks at how rate changes are likely to affect borrowers in the Baltic states.

2022 will go down in monetary policy history as the year of new inflation records and tectonic shifts in Central Bank monetary course, from the excessively slack policy at the start of the year to the significantly restrictive at the end of the year.  Could the restrictive policies of Central Banks ease up next year, and will the payments of Baltic borrowers continue to rise after the latest rate increases?

In the middle of December, the largest Western Central Banks gathered for their final meetings of the year. The first signs of slowing inflation, alongside the recent massive rate changes, allowed the U.S. Federal Reserve System (FRS) and European Central Bank (ECB) to reduce the speed of rate increases in December. Base rates on both sides of the Atlantic were raised by 0.50 percentage points after a previous raise of 0.75 percentage points.

Since March this year, the base rate in the U.S. has increased from almost zero to the 4.25% - 4.50% range. The ECB’s active fight against inflation began later, in the middle of the summer, and within six months ECB has raised the entire set of rates by 2.5 percentage points, with the main refinancing rate reaching 2.5% and the deposit rate reaching around 2.0%. With these swift increases, rates soon reached a level which is considered restrictive for the economic activity.

Although Central Banks still have an aggressive outlook and plan to continue raising rates in the near future, this leads us to believe that the peak of the rate increase process is not far off. December’s rate changes were widely expected and calculated into forecasts, but there is far greater interest in what the future holds. In accordance with the latest FRS December forecasts, base rates in the U.S. could peak at around 5.00% - 5.25%. This is higher than the FRS itself predicted in the autumn, as well as above current market forecasts. Unlike the FRS, the ECB is not communicating explicitly its plans, but confirmed that it would continue its campaign of rate increases.

Looking at the future rate trajectory, there are many open questions. First, how severe will the expected economic weakening be next year? Currently, something between stagnation and recession is expected both in the U.S. and in Eurozone.

Second, how strong will the regions’ job market and internal demand remain? Over the course of the year, these were the two main sources of positive surprises in Western economies, which also put upward pressure on inflation. Third, how will the situation in the energy markets, particularly the European gas market, continue to develop? All these factors will impact decisions made by Central Bank bankers next year.

Judging by financial market indications, market participants do not expect FRS rates to climb above 4.75% - 5.00%, assuming that the economic reality will force the FRS to move in the opposite direction in the second half of next year. Market forecasts envisage that dollar rates could move closer to 3% by the end of 2024.

Baltic countries will feel the impact of the latest decisions

Financial market participants expect Eurozone base rates to reach their highest point at or slightly above 3%. Bearing in mind the higher levels of inflation and greater uncertainty over energy price dynamics in Europe, the expectation is for rates in the Eurozone not to decrease significantly over the next few years. Judging by current market indications and forecasts, over a three-year horizon ECB base rates and therefore also the three-month EURIBOR could stabilize at around 2.5%, while the six-month EURIBOR could be slightly above this level.

The ECB’s monetary policy decisions continue to impact borrowers in the Baltics. Bearing in mind that variable loan interest rates — EURIBOR — are set for a certain term, all current borrowers have yet to feel the full effects of higher rates on their loan payments. However, at the same time, estimates predict that the latest ECB decision on rate raises could increase loan payments by up to around 5% of current monthly payments.

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