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Consumers: Borrowers hope for a reduction in interest rates

Consumers: Borrowers hope for a reduction in interest rates

Inflation in the euro area is on the decline again after the price shock caused by the war in Ukraine. This gives the ECB leeway – longed for by borrowers and feared by savers.

Loans have become more expensive since the end of the zero interest rate phase in the euro area. Property buyers, house builders and companies are therefore hoping for a reduction in key interest rates soon. So far, however, the euro’s monetary authorities have not relaxed the interest rate controls despite significantly lower inflation. This Thursday, the Council of the European Central Bank (ECB) will decide on the further course of monetary policy.

How is inflation developing?

After reaching record highs as a result of Russia’s war of aggression on Ukraine, inflation in the common currency area of ​​the 20 countries has now fallen significantly again. In March, consumer prices rose by 2.4 percent compared to the same month last year, according to an initial estimate by the statistical office Eurostat. In March 2023, the inflation rate was still 6.9 percent.

“The only downside remains the stubbornly high price dynamics for services,” said NordLB chief economist Christian Lips about the current figures. “The upcoming wage agreements are of great importance here, which is why the ECB wants to wait for new data on wage developments.” Commerzbank chief economist Jörg Krämer warns: “In the fight against inflation, the last mile is the most difficult.” The ECB is aiming for an annual inflation rate of two percent in the medium term. At this value, the monetary authorities see price stability guaranteed. Higher inflation rates reduce the purchasing power of consumers. You can then afford one euro less.

Why is the ECB hesitant to cut interest rates so far?

In order to get the temporarily high inflation under control, the monetary authorities ended the years of zero and negative interest rates in July 2022 and increased interest rates ten times in a row. Inflation is now approaching the 2 percent target, but the central bank wants to make sure that the danger of sharply rising prices has actually been averted. The recent development of the inflation rate makes the monetary authorities more confident, but “not sufficiently confident,” ECB President Christine Lagarde said after the council meeting in March.

According to BVR chief economist Andreas Bley, there is much to suggest that inflation will continue to fall, but uncertainty remains high. Energy prices are currently rising again and wages are growing strongly. The ECB should therefore make any further interest rate hikes dependent on the data situation. “An up and down in the key interest rate would lead to great uncertainty among citizens and the financial markets.”

What do the ECB’s decisions mean for savers?

Since their peak at the end of last year, fixed-term deposit interest rates have already fallen noticeably, according to data from the comparison portal Verivox. Fixed-term deposits available nationwide with a term of two years currently yield an average of 2.89 percent (as of April 4th), at the beginning of December it was 3.36 percent. Verivox expert Oliver Müller explained that a key interest rate cut in the summer is already largely priced into the current fixed-term deposit conditions. “If, in view of the reduced inflation in the euro area, the monetary authorities promise not just one, but even two cuts in key interest rates, fixed deposit interest rates could fall even further.”

Savings are invested in a fixed-term deposit account for a specific period of time. Savers cannot access the money during this time and financial institutions cannot adjust their conditions. Financial institutions therefore try to take the expected interest rate developments into account in advance.

According to Verivox data, the interest rates on offers available nationwide are stagnating at an average of 1.75 percent. “In the future, we also expect falling interest rates for overnight money,” said Maier. Credit institutions can change the interest rates for deposits available on a daily basis at any time and adapt them to the current market situation.

What do falling interest rates mean for borrowers?

Deka Bank chief economist Ulrich Kater, like many other economists, believes a key interest rate cut in the euro area is likely from June. “However, consumer loans or construction financing will no longer become much cheaper, as a number of future interest rate cuts have already been anticipated under current conditions,” says Kater. According to data from FMH-Finanzberatung, for example, an average of 3.48 percent per year is currently due for ten-year building loans (as of April 8th) – at the end of October it was still over four percent.

How are interest rates and the economy related?

Higher interest rates make loans more expensive, which can slow down demand. This helps reduce the inflation rate. At the same time, more expensive loans are a burden on the economy because loan-financed investments become more expensive. Some companies are therefore reconsidering their investments. Private house builders as well as large investors are holding back on construction projects. This, along with other factors such as weaker world trade, could dampen economic development in the euro area. The economic prospects for the common currency area had recently deteriorated. In its most recent forecast in March, the ECB predicted 0.6 percent growth for this year; in December, 0.8 percent was still expected. Because of the economic weakness, there were calls for interest rate cuts to be made soon.

Source: Stern

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