The European Central Bank (ECB) regularly gets together to make changes to the short-term interest rates across the Eurozone. But what exactly does it mean when interest rates are cut?
The key ECB Policy Rates are the interest rates used to get overnight liquidity or for the overnight deposit facility. It directly influences the interest rates that financial institutions are then able to offer to their clients.
More: https://www.banque-france.fr/en/economics-statistics/rates/policy-rates.html
Before we talk about the ways consumers are affected, it is important to understand why the ECB changes the target, or nominal rate. The nominal rate is an example of monetary policy enacted by the ECB to achieve short-term economic goals like price stability, low inflation, and steady economic growth. Changing the rate helps achieve these things by increasing the money supply, making it easier for banks, then businesses, then ordinary people, to borrow money and spend it. This also works in the other direction, and the ECB can raise the nominal rate when there is too great a money supply (too much inflation) in the economy.
Consumers and corporations interact with the the ECB’s nominal rate in many ways. For corporations, their primary interaction is in the area of:
Because consumers cannot be as creditworthy as corporate bank customers, they are primarily affected by lower interest rates in other ways:
| Product | Impact for the consumer | Rational |
| Mortgages | + | For consumers with an adjustable-rate mortgage, a rate cut will result in lower mortgages payments. This is because adjustable-rate mortgage (ARM) payments are directly linked to the Euribor, which tends to fluctuate with the nominal interest rate set by the ECB. Of course, consumers with a fixed-rate mortgage should not expect to see any change in their mortgage payments as a result of a nominal rate decrease. |
| Credit Cards with overdraft | + | As with mortgage rates, consumers with overdrafts at variable rate will be impacted. Overdraft interest rates are often correlated with the nominal rate. So, a nominal rate decrease will likely result in lower interest charges on a credit card. |
| Savings | - | Here is an area where consumers won’t benefit. Lower ECB interest rates usually mean less interest earned on savings. This is because banks usually lower the interest rates paid on most bank holdings, including saving accounts, term deposit accounts, etc. |
| Money Market Accounts | - | Money market accounts (MMAs) will show an interest rate reflective of the lowered nominal rate. This is because banks typically use MMA deposits for investment in safe assets like short term state bonds (few months), which bear rates close to zero (if not negative). |
| Bond funds | + | A fund which invests in bonds gets “fixed income” from his investment (“coupons”). If the yield that you can expect from the market decreases (eg. because ECB reduces nominal rates), the relative value of these coupons increases. In mathematical terms: the net present value of the expected cash flows increases. Therefore, the overall value of your investment increases. |
In conclusion, we now understand the ECB uses its nominal rate setting powers as a monetary policy tool. The effects of a lowered nominal rate are many, and they affect banks, corporations, and consumers alike.