In the fight against inflation that degenerated into the 2022 energy crisis, the ECB increased key interest rates from 0.0 to 4.5 percent. The inflation rate has fallen significantly again. In January it was 2.9 percent in Germany and 2.8 percent in the entire euro area. Francois Villeroy de Galhau, head of the French central bank and member of the ECB's Governing Council, has now indicated that this is no longer too far from the ECB's target of 2.0 percent. “We will probably cut interest rates this year,” he said in a television interview, “the need to fight inflation is slowly ending.”
Economists expect the first reduction in key interest rates in June, and some analysts expect it as early as April. Villeroy himself still did not want to commit to a date. The ECB would decide based on current data. In a first step, interest rates are likely to fall by only 0.25 percent. But what would be the effects of this on your money? Here are some examples.
1. Daily allowance
For a long time there was almost no interest on checking accounts and savings accounts. With the ECB's interest rate hikes, overnight rates also rose again. From an average of 0.03 it went to 2.1 percent. If we follow the logic that overnight interest rates are on average half of key interest rates, they would fall by 0.12 percent if interest rates were cut.
With an investment of 10,000 euros, this would mean an interest loss of 12 euros per year. For 100,000 euros it would be 120 euros. However, in the medium term interest rates are likely to fall more sharply. If the interest rate falls to around 2.0 percent, daily savers with an investment of 10,000 euros would already lose 1.16 percent or 116 euros per year.
2. Real estate loans
As key interest rates rise, loan interest rates also rise. Although this applies to all types of loans, here we will limit ourselves to real estate loans. They rose from 0.9 to 4.1 percent. Since December they have fallen again to 3.3 percent. This is likely in anticipation of possible interest rate cuts by the ECB. Since real estate loans have a very long term, the evolution of the interest rate market is taken into account beforehand. Therefore, an interest rate cut by the ECB of 0.25 percentage points should have no impact.
Interest rates on promissory notes, such as government bonds, always compete directly with interest rates on savings accounts. Why should you invest your money in a bond if its yield is lower than that of a checking account? That is why significantly higher interest rates, between 2.6 and 3.7 percent, are currently earned even on super-safe German government bonds than on overnight money.
Government bond interest rates react very sensitively to interest rate cuts and are therefore likely to fall to the same extent as savings deposits. If you already own a bond, it doesn't matter because you will get the interest rate that is written on the bond. Only new bonds with less interest are issued.
In theory, stock returns move inversely to key interest rates. The logic behind this: The higher the key interest rates, the higher the interest rates on savings and bonds and the less attractive stocks become. Because fewer people buy stocks, prices don't rise as much as before.
Recent years have shown that this logic does not always have to be correct. Since the ECB's first interest rate hike at the end of July 2022, the Eurostoxx index has risen around 36 percent. The German DAX rose around 32 percent. You would never have earned so much on your savings during this time.
Consequently, it is difficult to predict how the stock market would react to an interest rate cut. In theory, companies could borrow cheaper, invest more, and increase their productivity and therefore profits more easily; that would make the stock more attractive.
Who really benefits from high interest rates?
Basically, high interest rates are good for everyone who makes money through interest transactions. These are mainly banks and insurance companies. When interest rates are high, the former have more room to optimize their spreads between key interest rates and lending and savings interest rates. Insurance companies benefit from higher interest income because their expenses are typically fixed. Especially pension insurance companies often invest their clients' money in safe bonds, which generate more profits with high interest rates.
Lower interest rates are good for anyone who needs or wants to go into debt. This applies to states that have to pay less interest on their bonds, as well as companies that finance new factories, machines and offices with loans, as well as individuals who pay for the purchase of houses or cars with loans.
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