The financial crisis and the pricing of interest rates in the Irish mortgage market: 2003-2011

This paper examines the changing manner in which Irish financial institutions set their variable interest rates over the period 2003 - 2011. In particular, the onset of the financial crisis clearly results in a break in the pass-through relationship between market rates and variable rates at the end of 2008 in the Irish mortgage market. Until the end of 2008 variable rates for all lenders closely followed changes in the ECB’s policy rates, short-term wholesale rates and tracker rate mortgages. Thereafter, the relationship breaks down, in part due to banks’ increased market funding costs. It appears that some lenders with higher mortgage arrears rates and a greater proportion of tracker rate loans on their books exhibit higher variable rates. After controlling for these factors and additional funding costs, most of the divergence between banks’ variable rates is explained, but there are some exceptions. There is also some evidence of asymmetric adjustment in rate setting behaviour: that is, rates tend to adjust slowly when they are above the long-run predicted level but more quickly when they are below this level. This asymmetric adjustment behaviour appears to increase in the post-2008 period.