Portugal among the European countries most vulnerable to ECB interest rate rises
A study by two ECB analysts reveals that, when the central bank decides to raise interest rates, Portuguese households feel the impact more acutely than almost all other Europeans.
When the European Central Bank (ECB) raises interest rates, the impact is not felt equally across all Eurozone countries. In Portugal, the rise in the cost of mortgage lending results in a particularly sharp contraction in household consumption, and the reason lies, to a large extent, in the way Portuguese people live and take on debt to buy a home.
This is the main conclusion of a new ECB working paper, authored by economists Paola Di Casola and Magdalena Grothe, which analyses how housing wealth determines the effectiveness of monetary policy in 20 advanced economies between 1995 and 2023.
The study identifies three main factors that explain why the same decision by the Frankfurt-based institution has such different effects from country to country: the proportion of homeowners; the level of household debt relative to GDP; and the prevalence of variable-rate mortgages.
According to the authors, “the effect of monetary policy on consumption is stronger in countries with a higher proportion of homeowners, a higher level of household debt relative to GDP, and a larger share of variable-rate mortgages”.
Portugal scores highly across these three dimensions, placing it among the countries where the ECB’s monetary policy has the greatest impact on household finances; this serves as a warning that takes on particular significance at a time when several analysts are forecasting a return to rising key interest rates.
Conversely, countries such as Germany and France, where home ownership rates are lower and fixed-rate mortgages are the norm, absorb Frankfurt’s decisions in a more cushioned manner. The contrast is telling: “In countries such as Spain and Ireland, where the homeownership rate is above 70%, the effects of monetary policy on consumption are significantly greater than in Germany or France”, write Paola Di Casola and Magdalena Grothe.
Portugal stands at a similar level to Spain and Ireland on this indicator, thus joining the group of European countries where a one-percentage-point rise in ECB interest rates is more likely to curb private household consumption.
Variable-rate mortgages as the epicentre of monetary transmission
One of the central concepts of the study is the so-called “housing wealth multiplier”, which measures how much household consumption fluctuates in response to an exogenous change in house prices.
The authors conclude that this multiplier “is strongly correlated with the proportion of outright homeowners — those with no mortgage — and is higher for durable goods”. This means that homeowners who have paid off their mortgage and have no outstanding debt tend to spend more when the value of their home rises and to cut back on spending when that value falls.
In the case of durable goods — cars, household appliances, furniture — the effect is even more pronounced, with consumption reacting significantly more strongly to fluctuations in property prices than is the case with non-durable goods. But it is through the so-called cash-flow channel that the transmission of interest rates to consumption is best explained in the case of Portugal.
Unlike in countries such as Germany, where fixed-rate mortgages predominate, the overwhelming majority of Portuguese households have mortgages indexed to market interest rates, particularly the Euribor. Thus, when Frankfurt raises interest rates, monthly mortgage repayments increase almost immediately, reducing the disposable income of Portuguese households and, consequently, consumption.
“Variable-rate mortgages adjust more quickly to changes in monetary policy rates, so a higher proportion of households with this type of loan implies greater sensitivity to changes” decided by the ECB, the economists emphasise.
The study also carries out a revealing counterfactual exercise, starting with the question: what would happen to consumption if house prices remained unchanged following a monetary policy shock?
The results show that, for Portugal, “the response of consumption converges to zero more rapidly” than in other countries when the effect of house prices is isolated, suggesting that the collateral channel, through which a fall in property values reduces households’ borrowing capacity, is particularly active in the country.
Portugal shares this characteristic with Australia, Canada, Denmark, Ireland, Norway and New Zealand, economies where the housing and mortgage markets play a very significant structural role in monetary transmission.
The implications of this study go beyond academic analysis. The authors warn that structural changes in the housing and mortgage markets, “such as the rise in the number of indebted homeowners or the reduction in the proportion of variable-rate mortgages, may have affected the strength of monetary policy transmission to consumption via the housing market” between 1995 and 2023 – the period analysed by the economists.
For Portugal, where the transition to fixed rates is still in its infancy and households’ exposure to variable-rate loans remains high, the ECB study serves as a reminder that decisions taken in Frankfurt have an impact in Lisbon with a force that few other eurozone countries can match.
