Navigating through the sudden increase in interest rates | Gordon Cordina, Kenneth Farrugia

The spike in energy and food prices caused by the war in Ukraine led the European Central Bank (ECB) to raise its interest rates by 1.25% over a few weeks. The ECB also stated that “based on its current assessment, over the next several meetings the Governing Council expects to raise interest rates further”. In the financial world, this was no less than a tectonic shock, following upon a decade during which banks could borrow money from the ECB at no interest and had actually to pay interest to deposit their surplus funds. During this time, interest rates for bank loans and deposits in Malta have fallen to their lowest levels ever.

As was the case when interest rates were falling, interest rate increases by the ECB do not translate automatically into equivalent and immediate changes to the rates charged by banks to their borrowing customers, or the rates offered on deposits. So far and for the foreseeable future, Bank of Valletta is not feeling the need to adjust its interest rates, because it is funded by a strong liquidity position, underpinned by both personal and corporate deposits, which does not make it dependent on ECB funding.

While the ongoing inflationary pressures are driven by the disruptions to the global supply chain, the ECB is likely to continue raising interest rates until price inflation slows and adopts a direction towards its 2% inflation target over the medium term.

Thus, over the longer term, a higher interest rate scenario could need to materialise in Malta, as domestic monetary and financial conditions cannot remain insulated from permanent changes in interest rates in the euro area for an indefinite period. In a sense, this would be a return to more normal levels of interest rates following a decade of unusually low rates, which was to be expected.

What was however not expected was the rapidity and extent to which the ECB is increasing its interest rates in the current situation of extraordinary inflation, and which is already having impacts on bank interest rates in other euro area countries

The prudent stance generally adopted by domestic banks in their lending practices over past years should ensure that customers can cope with their debt servicing obligations. This served the country well in the context of the recent highly challenging COVID environment that threatened the sustainability of many commercial enterprises.

Banks in Malta also take great care in assessing affordability when granting loans, by making allowance for possible higher debt servicing costs.

It is however also important to consider that higher interest rates on loans would have impacts on the costs of business and on the purchasing power of households in an inflationary environment that is presenting new challenges of its own right, with implications for economic performance and the overall well-being of society.

Looking ahead, BOV’s future base rate will need to be shaped by the overall size and pace of the ECB’s interest rate decisions going forward, especially if such changes become of a more permanent nature.

Bank of Valletta will continue to closely monitor developments in ECB policy rates, as well as the actions of the other major banks in Malta, with the aim of striking the right balance among its stakeholders, both depositors and borrowers, when setting its interest rate structure. The strong liquidity position through which the Bank is funded will help to ensure that any future changes in interest rates will be well-managed, gradual and to the extent possible, without surprises.

Gordon Cordina is Bank of Valletta chairpersons, Kenneth Farrguia is CEO-designate