What the interest rate policy means for you

What the interest rate policy means for you

For years the money of the savers ekes out a rather scanty existence. While conservative investment strategies do not yield much, share prices and real estate prices are constantly climbing new heights. How the ECB’s interest rate policy affects the money and capital markets, and how this affects your savings account or retirement plan.

The starting point for the interest rate policy of the European (ECB) central bank is economic development in the euro area. The economy should be buzzing, but the price level should remain stable and the inflation rate at a certain level. To get closer to this goal, interest rates can either be raised or lowered.

The ECB has three tools at its disposal: the main refinancing rate – generally referred to as the base rate, the deposit rate and the marginal lending rate. They determine the conditions under which commercial banks can either procure or invest money at the central and central banks. Thus, they provide an orientation function for the money markets and indirectly influence the capital markets, ie the prices for bonds, stock prices but also property prices and the euro exchange rate. (Read more: The Federal Reserve’s Interest Rate Instruments.)

What are the effects of raising or lowering the base rate?
Rate hike: Raising the key interest rate points the way into a restrictive, so restricting monetary policy. With a generally good economic situation, a too rapid increase in the inflation rate should be counteracted. By raising the interest rates, the lending rates increase, that is, the borrowing costs more. On the other hand, the credit interest increases, savers get more money. On the capital markets, bonds are in greater demand than equities.

Interest rate cut: With a cut in the key interest rate, the ECB is following the course of an expansionary monetary policy. The reception of money at the central bank is cheaper. This is also reflected in the credit conditions of the banks. The aim is to create an investment incentive for companies and to encourage consumers to consume in the form of consumer credit and thus stimulate the economy. If loans are cheaper, on the other hand, the credit interest sinks. Savers get less for their investment. Since bonds are hardly worth anything, investors are increasingly investing in the stock market or in real estate.

What dangers lurk in cheap money?
For years, the central banks have been trying to help the economy with cheap money and at the same time to fuel inflation. However, ultra-loose monetary policy risks jeopardizing the financial markets in the long term. For example, bubbles can form on the stock or real estate market, with prices inflating beyond healthy levels. Economists have been urging the ECB for some time to abandon the open money-locker.

What are negative interest rates and what does that mean for my savings account?
For some time, the term of “negative interest” makes the rounds. For example, some banks have already introduced a negative interest rate on their investments for companies or savers with higher savings. But what is it actually: negative interest?

Currently, commercial banks have to fork out a negative interest rate of 0.40 percent when they park money with the ECB. While the ECB wants to encourage banks to increase lending, they are considering giving this amount – also known as penalty interest – to their customers. This should in turn increase the incentive for bank customers to spend their money instead of keeping it on the passbook.

Small savers are still not affected by this step. But it seems only a matter of time, until so-called penalty interest is charged on the savings of retail investors. According to a survey conducted by the Bundesbank and the BaFin Financial Supervisory Authority, every twelfth bank intends to charge negative interest on deposits from private customers. With banks cutting back on revenue because of low interest rates, they’re passing on the costs to their customers and turning the price screw. In the future, one or the other saver will be confronted with penalty interest for his savings.

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