The ECB’s turnaround in monetary policy: which key interest rate is important for savers

What many do not know: There is not one key interest rate of the ECB, but three. While one is particularly in the focus of the media, another is of particular importance to savers.

When the European Central Bank meets today, one thing is certain: the European currency watchdogs will initiate a turnaround on interest rates and raise key interest rates. Plural, not singular: Because the ECB actually has three key interest rates in its repertoire. However, these three interest rates have very different effects and sometimes have a more, sometimes less direct impact on consumers, savers and investors.

In focus: the main refinancing facility

The main refinancing facility is usually the focus of the media. This determines the interest rate at which banks can borrow money from the central bank over a longer period of time. The minimum term here is one week. Since the financial crisis of 2008, this key interest rate has been exactly zero percent. At its last meeting, the ECB announced an increase in the main refinancing rate to 0.25 percent. In the meantime, there is even speculation on the market about a large interest rate hike of 50 basis points.

The following applies: if the main refinancing interest rate rises, it is not just the costs for banks that rise. The financial institutions usually pass on the increased costs directly to consumers and companies in the form of higher interest rates on private and corporate loans. And that is exactly what the ECB wants.

fight against inflation

The main refinancing facility thus has a direct effect on the amount of expenditure, borrowing and savings within the currency area. It therefore plays a crucial role when it comes to stopping inflation and getting inflation expectations under control.

In view of a record inflation of 8.6 percent in June in the euro zone, this is also urgently needed. Inflation in the monetary union is thus more than four times as high as the ECB’s target. The currency watchdogs are aiming for inflation of two percent in the medium term. In the eyes of the ECB, an inflation rate that is too low is just as negative as an inflation rate that is too high.

Top lending rate – overnight loans for banks

However, the top lending rate also plays an important role in the fight against inflation. The top lending rate quantifies the cost at which banks can borrow money from the ECB in the short term, say overnight. It has been 0.25 percent since March 2016.

The European Central Bank controls the supply of liquidity to the commercial banks with the top refinancing rate. A low top lending rate tends to lead to an increased money supply and to an accelerated velocity of money circulation and thus to rising inflation. In the fight against inflation, the ECB is therefore likely to raise this key interest rate by 0.25 percentage points today.

Negative deposit facility should be history soon

The counterpart of the marginal lending facility is the deposit facility of the ECB. This means that overnight investments by commercial banks with the central bank earn interest. If it is positive, banks that “park” excess liquidity with the ECB make money. However, the deposit rate has been negative since 2014 and has been minus 0.5 percent since 2019.

Banks that do not manage to pass on excess money as credit or to lend money to other banks are therefore punished by the ECB. Most recently, however, the monetary watchdogs announced that they would raise the deposit rate to minus 0.25 percent at their July meeting. By autumn at the latest, the negative interest rate should finally be history.

Savers were left behind for a long time

This is also good news for savers, as their financial institutions have recently asked them to pay more and more. Some of the banks had passed on the negative deposit interest directly to private customers in the form of a so-called “custody fee”.

Bank customers had to pay interest to their bank for credit balances in current accounts – sometimes from as little as 5,000 or 10,000 euros. In anticipation of rising interest rates on deposits, many banks recently announced an (soon) reduction in custody fees or at least an increase in the exemption limit.

Custody fee before the end

Some banks have even completely abolished negative interest on deposits in anticipation of the ECB’s change in monetary policy. Experts are convinced: At the latest when the deposit facility is back to zero, the penalty interest rates for savers should be eliminated across the board.

But savers should not be misled by one thing: the real interest rate, i.e. the nominal interest rate minus the inflation rate, is likely to remain in negative territory for a very long time.