There is some relief in sight for the farmers and businesses who have had to deal with higher borrowing costs over the past few years.

Data on inflation in the euro area released this week showed that inflation has fallen to the slowest rate in three years, dropping to 2.2% in August.

A similar release for Ireland showed inflation here is estimated to have fallen to 1.1% for the year to August.

The slowdown in inflation gives the European Central Bank (ECB) room to cut interest rates at its meeting on 12 September, a move it is widely expected to make.

However, for businesses and farmers to see a meaningful drop in borrowing rates, the central bank will have to follow up September’s move with further cuts over the following months.

Financial markets forecast that the ECB will make six quarter-percentage point cuts by the end of 2025, leaving its key interest rate at 2.25% at the end of next year (see Figure 1).

The risk to this outlook is how inflation develops over the coming 18 months. While the headline rate has hit the slowest level in three years, there are some components of inflation which are still worrying for policymakers.

Concerns

In particular, the rise in inflation in the services sector, from 4% to 4.2% for the year to August, could reduce the pace of rate cuts by the ECB.

If there are concerns that wage increases demanded to meet the higher cost of living themselves risk raising the cost of living, the ECB may be slow to cut rates, as they could fear that inflation is at risk of entering a wage-price increase cycle - where higher costs lead to higher wage demands, which in turn lead to higher costs, which lead to fresh wage increase demands.

The rate of services inflation is likely to become the most important factor in deciding whether the ECB rate path follows what markets expect or whether they follow a slower path, leaving borrowing costs for business and farmers higher for longer.

Irish banks

There have been complaints in the past about Irish banks being slow to pass interest rate cuts from the ECB on to borrowers. The banks make the counter-argument that they did not move borrowing costs up as much as the central bank did when it was increasing rates.

As the main Irish banks are almost entirely funded from customer deposits these days, there is less of a direct connection between ECB interest rates and their cost of doing business.

This means they are in a position to make their own decisions on what they charge for loans and with competition remaining relatively weak in the sector, there is not a lot that can be done to force them to reduce rates.

Allied Irish Bank and Bank of Ireland made a combined profit of €2.2bn in the first six months of the year and said they expected net interest income (the difference between what they pay for deposits and what they charge borrowers) for the year to reach a combined €7.55bn.

To put that number in context, it is equivalent to around €1,500 for every person in the country, in one year.

Clearly, even if the ECB is slow to reduce rates, the Irish banks already have room to reduce borrowing costs.