One of the most important interest rates was raised again on Thursday by the European Central Bank (ECB). The higher interest rate is intended to curb inflation, but it affects the economy and your wallet in many more ways. How will higher interest rates affect your home, savings, investments and pension?
The ECB raised its policy rate from 2.5 percent to 3.0 percent on Thursday. This is the fifth interest rate increase since last summer after years of low or even negative interest rates. How soon will we notice such an interest rate increase?
“There is more than just the ECB interest rate at financial institutions, stock exchanges and consumers,” says ING economist Bert Colijn. “It is therefore difficult to predict how directly a higher ECB interest rate will affect you and me. That also remains difficult for the ECB itself.”
The interest rate increase was most visible on the stock market. There, investors are already counting on higher interest rates before they even arrive. For example, bond yields have been rising since early 2022, six months before the first ECB rate hike.
Turning the interest rate dial does not give full control over inflation
The main purpose of central bank interest rate hikes is to curb inflation so that prices also have to rise less for consumers.
According to the ECB, 2 percent inflation is an ideal rate. In recent years, the ECB has tried to raise inflation towards 2 percent with interest rate cuts. Inflation across Europe must now be reduced by making borrowing less attractive with higher interest rates.
But a direct effect is uncertain, Klaas Knot of De Nederlandsche Bank (DNB) recently acknowledged. “The interest rate knob that the ECB can turn, of course, does not give full control over inflation. We saw that with the low inflation that we had for a long time, and we see it now with the high inflation.”
Colijn notes that the high inflation is mainly due to higher prices for energy, container trade and computer chips. “The ECB has no direct control over this. But those prices have fallen again, while inflation is still high. That is why the bank tries to curb inflation as carefully as possible to prevent shocks on the financial markets and damage to the economy. Higher interest rates could jeopardize economic growth.
Colijn thinks that if wages rise faster than expected this year, inflation will decline more slowly.
Save more attractive, don’t borrow
Since the interest rate hikes by the ECB, interest rates on savings are also slowly returning. Last summer you received practically no interest on freely withdrawable savings. The major banks are now offering 0.5 percent and price fighters already 1.5 percent.
If you tie up your money for a longer period of time, for example five years, percentages of 2 to 3 percent are normal. Those are still relatively low percentages, but interest rates are slowly rising. Just as they slowly went down before.
Borrowing is actually becoming less attractive. Especially for companies, which can therefore make fewer investments. And that can slow down inflation.
Mortgage interest rates up and home prices fall
Borrowing money for your home is also becoming more expensive. Partly due to the higher ECB interest rate, mortgage interest rates for the most popular ten-year term have risen in the past year from over 1 percent to over 4 percent.
Homeowners often do not yet notice the effect of rising interest rates. Many have benefited from the low interest rates of recent years, sometimes locking them in for up to twenty years.
But buyers will notice the higher interest. As a result, they can now borrow less money. For that reason, house prices are likely to fall by about 4 percent this year, Rabobank recently predicted. Experts fear that falling house prices and more expensive mortgages will also put new construction projects under pressure.
Stock market not happy with higher interest rates
Rising interest rates are generally not good for stock prices. Because then it becomes less attractive to borrow and invest money. This slows down the economy somewhat. Future profits are also worth less at a higher interest rate. As a result, technology companies were the biggest losers on the stock market in 2022.
Bond prices also fall sharply when interest rates rise. Bonds, corporate or government debt, with lower interest rates in the past lose value. Investors notice this, but the beleaguered US Silicon Valley Bank also noticed this week. New bonds will become more attractive to investors because you get a higher interest on money that you lend to companies or governments.
In addition, interest rates also affect the exchange rate. Colijn: “If interest rates rise in Europe, the euro will become more attractive to investors. And that can have many effects, for example that Europeans pay less for oil because it is paid for in dollars.”
Investment loss for pension funds, but indexations
For pension funds, rising interest rates have two sides. On the one hand, higher interest rates lead to lower share and bond prices, which means that pension fund investments are worth less. In the past year, large pension funds suffered high investment losses of hundreds of billions. As a result, the assets of the funds shrank.
But the pensions to be paid out in the future will also be worth less at higher interest rates. To pay out 1000 euros in pension in 2050, you now need to have less money in cash at a higher interest rate. The value of pension benefits for the future fell even faster than the value of the invested capital. And that caused the funding ratios to rise. For example, pension benefits at some funds could be increased by 10 percent or more at the beginning of this year.
In the new pension system that is coming up, the pension benefit will be increased or decreased more emphatically on the basis of investment results and less on the basis of interest rate fluctuations.