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Article written by Simone Viganò, General Manager Casavo Mortgages
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On June 6, 2024, the European Central Bank (ECB) surprised markets by announcing an interest rate cut of 25 basis points. But what exactly does this cut mean? What are the implications for the housing market and mortgages?
In this article, we will explore in detail the meaning of the rate cut, how ECB rates work, and the impact on mortgages.
What is the ECB rate?
The “ECB rate” It mainly refers to the "main refinancing rate," also known as the Refi rate. This rate represents the interest rate that the European Central Bank applies to refinancing operations with commercial banks in the Eurozone. Essentially, it is the rate at which banks can borrow short-term money from the ECB.
In addition to the Refi rate, the ECB also sets two other key interest rates:
- Deposit rate: This is the interest rate applied to banks' deposits at the ECB.
- Marginal lending rate: This is the rate at which banks can borrow liquidity from the ECB. by the ECB for very short periods, usually one day.
These three rates together form the ECB's so-called rate corridor, which is one of the main monetary policy tools used to influence financial conditions in the euro area.
The Impact of the Refi Rate on the Economy
The Refi rate has a significant impact on the interest rates charged by commercial banks for loans to consumers and businesses. When the ECB lowers the Refi rate, it makes it cheaper for banks to borrow money, thereby encouraging spending and investment in the economy. Conversely, when the ECB raises rates, banks may be less inclined to borrow money, which could slow spending and economic activity, with the aim of controlling inflation.
Commercial banks refinance with the ECB when they need additional liquidity to meet reserve requirements, to cope with unexpected cash flows, or to better manage their liquidity position.
A Blast from the Past: The Era of “Whatever It Takes” by Mario Draghi
Many remember the period of the famous “whatever it takes” speech delivered by Mario Draghi on 26 July 2012 in London. Draghi declared that the ECB would do “whatever it takes” to preserve the euro and ensure the stability of the eurozone. This speech was made at a critical moment, during the sovereign debt crisis that threatened the stability of the eurozone. of the euro area.
At that time, the ECB's Refi rate was already at low levels, but it was further lowered to stimulate the economy and support the recovery. This period was characterized by interest rates close to zero, which led to very low interest rates for loans and mortgages.
A Disruptive Change: Monetary Policy from 2022
Since 2022, the ECB has adopted a policy of raising rates to counter rising inflation, caused by factors such as the reopening of post-pandemic economies, geopolitical tensions, and rising energy and commodity prices. The Refi rate was raised abruptly, from 0% in July 2022 to 4.50% in September 2023.
These increases were aimed at maintaining price stability and preventing high inflation from becoming persistent. However, they also led to higher borrowing costs for consumers and businesses.
The Impact on Mortgages: EURIBOR and EURIRS
When the ECB changes the Refi rate, this directly affects the EURIBOR, an index that represents the average rate at which major European banks lend money to each other for periods ranging from one week to 12 months. The EURIBOR is a key indicator for the cost of money in the short term and is used as a benchmark for determining variable interest rates on mortgages and loans.
The other important indicator is the EURIRS, or Euro Interest Rate Swap, which represents the fixed rate that one party would pay in exchange for receiving a variable rate for a period that can vary from 1 to 30 years. The EURIRS is mainly used as a benchmark for fixed-rate mortgages and other long-term financial products.
When the ECB increases the Refi rate, the EURIBOR tends to rise almost simultaneously, reflecting the increase in short-term borrowing costs. The EURIRS, on the other hand, is influenced by market expectations about the ECB's future monetary policies and by the long-term inflation and growth outlook.
A Practical Example: The Evolution of Rates in 2023
In 2023, we observed an increase in the Refi rate to 4.50% in September, which brought the 1-month EURIBOR above 3.8% and the 30-year EURIRS to 3.1% in October. However, when the ECB decided to keep rates unchanged in October 2023, the EURIRS was significantly lower. dropped to 2.2% in December, reflecting expectations of a future rate cut.
The June 6, 2024 Rate Cut: What Has Changed?
On 6 June 2024, the ECB announced a cut in the Refi rate of 0.25%, bringing it to 4.25%. This cut has been long-anticipated, but it is not yet clear whether it is sufficient to have a significant short-term impact. The ECB is expected to make further cuts by the end of the year, for a maximum of two reductions.
Reasons for the Cut
The Refi rate cut reflects the slowdown in inflation, accompanied by positive signs of economic growth and improving employment in the eurozone. However, a return to particularly low interest rates is not expected in the short and medium term, as the ECB wants to balance the need to support the economic recovery without compromising the stability of the euro area. of prices.
Impact on EURIBOR, EURIRS and Mortgages
EURIBOR
After the announcement of the rate cut, EURIBOR recorded a decrease of around 20 basis points, leading to a reduction in rates on variable-rate mortgages. This is an immediate benefit for those with mortgages indexed to EURIBOR.
EURIRS
EURIRS, on the other hand, did not show significant changes in the days immediately following the announcement, as Market expectations of future rate cuts had already been largely priced in in the previous months. A slight decrease in the following weeks is expected, albeit by a few basis points. As a result, fixed-rate mortgage rates remained virtually unchanged in June. unchanged from May 2024 levels.
What Does It Mean for Borrowers?
Variable Rate Mortgages
Borrowers with variable-rate mortgages will immediately benefit from the rate cut, with a reduction in their monthly payments. However, it is important to monitor future ECB decisions, as further cuts could lead to further interest rate decreases.
Fixed-Rate Mortgages
For those who decide to take out a fixed-rate mortgage at this juncture, the impact of the rate cut is significant. The ECB's interest rate cut marks a change in direction from the rate hikes of recent years. This cut signals support for the economic recovery and could lead to lower borrowing costs for consumers and businesses. However, it is important to keep in mind that interest rates will fall again - but not significantly - in the coming months.
For real estate sellers, it is advisable not to wait for further interest rate reductions to stimulate buyer demand. Current interest rates are already favorable for fixed-rate mortgages, and waiting for further reductions may not be a winning strategy. The real estate market currently offers good sales opportunities thanks to the stability of the Eurirs. potential buyers should, however, seriously consider taking out a fixed-rate mortgage now. In any case, remember that choosing a mortgage isn't forever: if rates were to drop further, there's always the option of subrogating to benefit from better conditions.
If you're thinking about a mortgage but don't know where to start
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