swap rates and mortgage rates

[kildon]

Hi,

Has anyone come across any articles which explain how exactly the swap rate affcts (i) variable rate interest and (ii) fixed rate of interst

Also, how do banks set fixed interest rates?

Why do fix rates go up before variable rates?

If the EU is expected to recover in 2010 and interest rates start to increase, would everyone not be better off fixing their mortgage at historical lows today?

Thanks
K

 

[North Star]

In simple terms, the fixed rates are priced off the interest rate swap curve (this prices swaps across all different maturities e.g 3yr 5 yr 10yr etc These swap rates are determined by the market and and move in in line with expectations on interest rates. These rates create the yield curve i.e rates for different maturities , ( wikpedia or google will provide countless articles on the yield curve ) The yield curve is upwardly sloping as the market has already priced in economic recovery and in time higher rates. Therefore 5 year rates are higher than 1 or 2 year rates.

Variable rate are more linked to short term rates which are set by the ECB. Though they are less linked than they used to be as funding levels are higher due to short term Euribor rates being elavated against the ECB repo rate ( sorry about being technical).

For both fixed and variable rates the banks add on margin to cover the credit risk, the level of this margin can be impacted by competition. (of which there is precious little at the moment)

So if you fix your rate today for 5 years you will fix on a forward looking i.e higher rate as the market has already priced in some recovery. In pure economic terms fixing makes sense if you expect rates to go up by more than the market currently expects.
Another benefit of fixixng is certainty, if someone's finances would be badly effect by rates rising above the current fixed rates, they could consider fixing and viewing paying the higher rate today as insurance against rates going even higher over the period of the fixxed rate. I hope this helps.

 

[kildon]

thanks for the response,

would it be fair to say that as the EU recovers in 12-24 months, all the money pumped into the economies will cause inflation to rise and therefore the ECB will increase rates to keep inflation down to the target level of 2%. Ireland's recovery will lag that of the EU by 6-12 month (probably) and so although other countries are coming out of the recession and can absorb the increased cost of mortgages from the ECB interest rate increases better than Irish mortgage holders who are still in recession but would then face the prospect of rising mortgage costs.
Is that a plausible scenario and so are 5/10 yr fixed rate mortgages at the bottom now?