MONETARY POLICY REPORT | AUTUMN 2022 (box 3)
(author: Renata Pašaličová)
This box focuses on the effects of the growth in interest rates on households’ and firms’ balance sheets via changes in their interest payments and income.
The effects of the increase in interest rates on households’ budgets
In 2022 Q2, total household debt stood at CZK 2,163 billion, more than three-quarters of which was housing loans. The growth in monetary policy and long-term market interest rates led to a rise in rates on new mortgages of 3.8 pp to 5.9% between June 2021 and September 2022 (see Chart 1). The higher price of loans was reflected in a drop in new mortgages and lower demand for property. This in turn is dampening growth in house prices, which enter inflation via the cost of owner-occupied housing.
Chart 1 – Rates on new mortgages and household deposits have risen in response to the CNB’s rate hikes
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The lower demand for housing loans has also caused households’ debt-to-income ratio to fall. Following significant increases in the past, in 2022 Q2, year-on-year growth in household debt slowed more than that in income and the debt ratio fell to 62%. Even so, the ratio of debt to disposable income is much higher than at the end of 2019.
Households’ housing-loan-related interest payments increased only slowly in the first half of this year (see Chart 2).[1] This is because rates on a large proportion of existing mortgages are fixed for several years in advance and an increase in client rates will only affect them when the fixed-rate period changes in the near or more distant future.
Chart 2 – Interest payments have risen slightly, but growth in interest income has been slightly greater, so the net interest paid by households has fallen
annual moving totals (sum of quarterly transactions) in CZK billions
The ratio of households’ total debt repayment costs (comprising payments of interest and principal on housing loans and consumer credit) to income changed little so far in the first half of 2022 (see Chart 3). Principal repayments have long been increasing in the debt servicing costs of households. This is due, among other things, to growth in the prices of the properties on which mortgages were taken out. The ratio of interest payments to income is close to an all-time low. However, the importance of interest payments is likely to increase as a result of the gradual refixing of mortgage rates at higher levels.
Chart 3 – Households’ total debt servicing costs have so far remained virtually unchanged relative to income
ratios to gross disposable income in %; CNB calculations
Until mid-2022, households’ interest income was rising considerably faster than their interest payments in response to the increase in interest rates. This contributed on the aggregate level to a reduction in net interest payments. The increase in income reflected, among other things, migration of deposits to products with higher interest rates, especially deposits with agreed maturity. However, a large proportion of household deposits still have low interest rates; in their case, client rates have responded to the increase in monetary policy rates to only a limited extent so far. The rate on the total deposits of households has thus risen only slightly recently (see Chart 1).
The effects of the increase in interest rates on firms’ budgets
The increase in monetary policy rates has been reflected in a faster and larger rise in the rate on new koruna loans to firms than in the case of households. Between June 2021 and September 2022, it went up by around 7 pp to 8.4%. A large proportion of corporate loans are negotiated with floating or short-term rates derived from money market rates. A change in interest rates thus shows up relatively quickly in firms’ interest payments. The rise in rates on koruna loans has also been reflected in increased demand of firms for euro-denominated loans, due to the high differential between domestic and euro rates.
The ratio of debt to gross operating surplus of firms increased moderately in late 2021 and early 2022 on the back of rising interest rates and slowing earnings growth. Continued significant growth in interest rates then fostered a slight decrease in firm debt in 2022 Q2 (see Chart 4). Firms’ debt-to-earnings ratio reached 74% in the case of bank loans and 201% for total debt (including non-bank financing and loans from abroad). The economic uncertainty, accompanied by limited investment activity and elevated interest rates, amid a persisting increased need to finance operating capital and inventories, started to manifest itself in a reduction in corporate debt.
Chart 4 – Firms’ loan debt is below the pre-pandemic level, while their debt servicing costs are higher
ratios to gross operating surplus in %; bank loans; CNB calculations
The growth in interest rates caused the interest payments of firms to rise in the first half of 2022 (see Chart 5). However, firms’ interest income increased even more sharply, so the net interest paid by firms thus fell more than that paid by households on the aggregate level. This is because firms are more active in moving their assets into higher-interest deposits and have a better bargaining position in relation to banks.
Chart 5 – The growth in firms’ interest income has outweighed the rise in their interest payments; the net interest payments of firms are therefore falling
annual moving totals (sum of quarterly transactions) in CZK billions
The changes in interest costs have also been reflected in the debt service of firms. The ratio of debt servicing costs – comprising payments of principal and interest (on koruna and euro-denominated loans) – to gross operating surplus has increased (see Chart 6). This has been fostered by a rise in interest payments associated with the repayment of koruna loans, as a change in market interest rates is immediately reflected in rates on new and existing corporate loans. The ratio of interest payments to gross operating surplus is therefore at its highest level since 2009. By contrast, principal repayments have recently decreased.
Chart 6 – Firms’ ratio of total debt servicing costs to earnings is increasing; principal repayments are falling
ratios to gross operating surplus in %; cost of total bank loans; CNB calculations
Conclusion
Overall, for households, the increase in the CNB's key interest rates has been reflected in a decrease in new mortgages and hence a reduction in their debt. Households’ interest payments on existing loans have so far been increasing slowly. Firms’ interest payments and total borrowing expenses have increased and their debt has fallen moderately. For both sectors, the rise in interest payments has been more than offset on the aggregate level in terms of balance sheet impact by higher interest income, so the net interest payments of firms and households have decreased. However, this income effect is secondary. From the point of view of monetary policy transmission, the decrease in demand for consumption and investment due to the increase in interest rates is the important effect.
More information on this topic can be found in a blog article on the CNB website: Klientské úrokové sazby z úvěrů a vkladů v kontextu zvyšování měnověpolitických sazeb (Client loan and deposit rates in a context of increasing monetary policy rates; available in Czech only).
[1] The latest available data on households’ and firms’ interest payments and income and debt service are available in the sector accounts for 2022 Q2. Interest payments and income are presented in the charts before adjustment for financial intermediation services indirectly measured (FISIM).