Understanding European Central Bank interest rates
European Central Bank interest rates refer to the levels of interest with which the ECB credits the borrower. With negative interest rates, you pay back less than you borrowed. This is because, as a borrower, you get money for free when you borrow it. For savers, on the other hand, negative interest rates mean that you lose money if large amounts are deposited with banks or savings banks - because as a saver, you are a lender. Banks work with funds that savers invest with them. You might think negative interest rates are topsy-turvy as savers should get money for their investment, and borrowers should pay interest. Find out more below.
ECB interest rate history
In June 2014, the European Central Bank (ECB) lowered the deposit rate for banks into negative territory, startling many savers and investors. However, interest rates have actually been falling since the early 14th century. This insight was brought to light in a long-term scientific study by Harvard scientist Paul Schmelzing, which reconstructs the real interest rates in the advanced economies since 1311. The study on historic interest rates in Europe contains a strikingly rich collection of records from diaries and accounts, local archives and municipal registers and includes everything from “Medici bank loans” to France’s “revolutionary loans” to the US government. Last year, Paul Schmelzing published an investigation into global interest rate trends since the Middle Ages. The current situation is not so unusual with regard to the course of historical development. Between 1313 and 2018, an average of one-fifth of advanced economies recorded long-term negative interest rates. However, there is no clear answer to why the interest rate level tends to continue to fall. Economists who have scrutinized the recent past cite changes in the pace of growth in establishing state stability and population size as the main factors.
What are ECB negative interest rates?
The amount of interest is based on the European Central Bank (ECB). One function of low-interest rates is that banks can borrow money from the central bank at a low cost and pass it on to the economy. The aim is to boost corporate lending and strengthen economic activity. But the reduction in interest rates did not lead to the desired result: the banks parked the money in deposit accounts. Therefore, the ECB tightened its monetary policy and lowered the deposit rate for banks in the negative range to - 0.5%. In addition, banks that park money in the ECB’s deposit facility and do not pass it on to the economy in the form of loans have to pay penalty interest. But even this measure has not yet led to the desired effect. More and more banks are passing on negative interest rates to their customers. The laws of supply and demand also apply to financial institutions and their customers, as in any market situation. Many banks in Germany do not need additional liquidity for which they would have to pay deposit interest.
However, customers can defend themselves against negative interest rates on savings. With fixed-term deposits, people can receive interest comparable to the income from alternative forms of investment such as money market funds or government bonds. Small savers are hit hardest by negative interest levels, so you have to actively look for alternatives in order to protect your savings from negative interest rates and inflation. Otherwise, they face a loss of purchasing power, and private old-age provision will also become much more difficult. But not only savers are affected by negative interest rates. Companies also suffer from the penalty interest.
Investing in real estate to avoid penalties
Savers with more than €50,000 in their accounts will end up paying to keep their money at the bank. Therefore, the best way to avoid losing hard-earned cash is to invest it in something tangible that will not lose value. Using capital as a downpayment on a mortgage is an excellent way to invest in something that will yield profit over a long period of time. Property buyers could use the money to buy their own home, or they could buy a rented property and enjoy profits from rental yields. Buy-to-let properties are often more affordable than empty homes, and cities like Berlin are seeing rising rents and skyrocketing property value, making now the perfect time to buy.