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The Central Bank building in Dublin Alamy Stock Photo

Households facing combined shock from inflation and interest rates

The Central Bank has published a new review into Ireland’s financial stability.

THE CENTRAL BANK of Ireland is requiring banks to hold more capital relative to their assets to help cushion against future potential shocks to the financial system.

A new Financial Stability Review published by the Central Bank today identified that the global economy is slowing as inflation persists.

In Ireland, the economy is facing downside risks – that is, possible losses in the value of investments – because of the extent of energy and inflation shocks.

The review said that households are facing a combined inflation and interest rate shock but suggests they are entering it with “strong balance sheet resilience”.

The share of households at risk of financial distress is projected to rise by up to one-third due to the inflation and interest rate increases – though it insists that “high degree of mortgage interest rate fixation, slow pass-through on SVR mortgage rates, substantial savings accumulation, nominal income growth in a strong labour market, strong housing equity positions, and prudent underwriting of mortgages in the last ten years” will “aid households to withstand current shocks”.

The Central Bank believes the economy and labour market will continue to grow but is cautioning of increased global risks to the financial system.

As a result, it is implementing several policies to safeguard financial stability, including an increase in the Countercyclical Capital Buffer.

A countercyclical capital buffer is designed to force banks to hold more capital relative to their assets as a protective ‘cushion’ for the future in case an event like a recession occurs.

“Given the central expectation for the economy, the fact that higher interest rates are expected to be positive for banks’ profitability, and the importance of building resilience in advance of a potential materialisation of risks, the Central Bank is continuing the gradual rebuilding of the CCyB,” a statement said.

“This marks a further step towards the 1.5% target rate for the CCyB in periods when cyclical risks are neither elevated nor subdued.”

Targeting property funds, the Central Bank is releasing new guidance on liquidity timeframes that mean the funds should provide for a minimum liquidity timeframe of 12 months, taking into account the nature of the assets held, and setting a leverage limit of 60%, restricting the amount of borrowed finance that they can use.

Releasing the report, Central Bank Governor Gabriel Makhlouf said that “as we and other central banks take the necessary steps to bring inflation back to target, there are undoubtedly risks of further asset price falls and, more significantly, potential episodes of disruption in segments of global financial markets”.

“We must remain vigilant,” Makhlouf said.

“The vulnerabilities accumulated during the period of low interest rates, along with the increasing interconnectedness of the modern financial system, means the full impact of shocks in this period of high volatility is hard to foresee with certainty.”

The review says that growing numbers of businesses are expected to run losses but that Ireland’s domestic economy is projected to grow in 2023, though not as much as in 2022.

“Profit margins are likely falling for large cohorts of the SME population, while a small cohort of more vulnerable businesses is likely to become loss-making based on price developments this year,” the review said.

“The sectors more affected by the pandemic are also more likely on average to be suffering due to inflation, highlighting the challenges posed by interlocking unexpected macro shocks.”

Confidence in the technology sector has declined in recent months and a weaker operation position has led to high-profile lay-offs, the review mentioned.

That weaker outlook for the technology sector risks “further exacerbating an already deteriorating demoestic macro-financial growht outlook”.

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