First Signs of Financial Stress From Rate Hikes Visible in Real Estate, Central Bank of Ireland Says

7 June 2023

By Xavier D’Arcy – DUBLIN (Econostream) – The recent tightening in monetary policy is impacting Irish financial stability, most notably in the commercial real estate sector, the Central Bank of Ireland said on Wednesday.

In its latest Financial Stability Review, the CBI said that the labour market in Ireland was particularly tight, representing an upside risk to inflation, but also providing a buffer for households against financial stress.

Risks to financial stability relating to higher interest rates were seen ‘most visibly and immediately in the commercial real estate market’, the CBI said. Commercial real estate was ‘perhaps the most vulnerable part of the economy’, Director of Financial Stability Mark Cassidy said at a press conference on Wednesday.

Further price falls in these markets ‘would pose risks to borrowers, and downside risks cannot be ignored’, according to the report. However, the knock-on effects for the banking system and wider economy ‘appear at this stage to be relatively contained.’

The ‘tight labour market continues to put upward pressure on the cost of labour’, and ‘the outlook for the labour market remains positive out to 2024’, the report said. Cassidy added that ‘this tight labour market and the fact that the economy is now at around full employment poses additional upside risks to inflation.’

Despite high inflation and rising interest rates, CBI Governor Gabriel Makhlouf said that it was likely that there would be ‘only modest increases in financial stress among domestic borrowers’. In Ireland, ‘lower levels of indebtedness, continued household income growth and robust employment remain a key source of strength’ for households, he said.

Ireland faced a unique situation with regard to financial stability risks, he said, with the Irish economy and the Irish financial system being ‘one of the most interconnected in the world.’

Recent banking turmoil in the US and Switzerland had ‘provided another example of the speed with which risks can materialise’, the CBI said. However, Makhlouf praised the Irish banking system’s resilience and said that while some borrowers will face difficulties, higher levels of bank profitability are likely to continue: ‘Of course there are tail risks that we must continue to factor in and be ready to address. However, the banking system has ample headroom above regulatory requirements in both capital and liquidity, with very high levels of cash reserves.  All of these support the resilience of the sector.’

Risks stemming from shadow banks, or ‘non-bank financial intermediaries’ as central banks prefer to call them, remained a key source of concern, according to the report. In the sector, existing vulnerabilities including liquidity mismatches, leverage and interconnectedness, ‘could amplify market shocks’. Price movements ‘could be amplified’ by these factors and ‘cause disruptions and spillovers across markets’, the report said.

The rapid tightening of monetary policy could give a rise to ‘doom loop’ dynamics in European sovereign debt markets as they were ‘likely to be particularly fragile amid interest-rate uncertainty and quantitative tightening’, the report said, though this was a ‘tail scenario’.