Understanding the implications of the recent interest rate reduction for you.
Following the ECB's decrease in the deposit rate by 0.25, bringing it to 3.50%, the situation for savers has grown grimmer. However, the cost of loans is expected to decrease marginally, but it remains uncertain if this reduction will be seen in mortgage financing.
In reaction to the continuously declining inflation rates within the euro region, the ECB reduced the primary interest rate, at which businesses can borrow from it within the euro area, by 0.60%. This now stands at 3.65%. If financial institutions deposit funds at the ECB, they will receive a quarter point less interest, amounting to 3.50%.
Survey portals have examined how this interest rate reduction affects consumers in various sectors, including mortgage lending, deposits, current accounts, and installment loans.
Fixed-term Deposits
The ECB's decisions in July 2022, September 2022, October 2022, December 2022, February 2023, March 2023, May 2023, and July 2023 led to an increase in interest rates for fixed-term deposits. This trend has come to a halt. Although major interest rates were previously at 4.25 or 3.75, fixed-term deposit interest rates had already fallen before the ECB decision. In November, time deposits with a two-year term yielded an average of 3.39%, but they are now at 2.68%, according to an analysis by comparison portal Verivox. On average, the interest rates of available offers across the nation have fallen by 0.71 percentage points. However, the inflation rate in August fell to 1.9%, its lowest level since March 2021. Consequently, the real interest rate of an average two-year fixed-term deposit has reached an all-time high of 0.78%.
Currently, you can earn 3.084% (Fordbank) for a one-year fixed-term deposit with German deposit insurance. Haitong Bank offers 3.534% via WeltSparen with a statutory deposit guarantee of up to 100,000 euros from the Portuguese deposit insurance fund. The average interest rate for fixed-term deposits is currently 2.67% for one year, as per FMH Financial Consulting.
Even with three-year terms, Haitong Bank from Portugal offers 3.534%. Without a broker, the French Stellantis Direct Bank offers 3.100% for three years. German deposit insurance is available for this period from Ford Bank at 3.084%. If you would like to keep your money invested for ten years, you can earn 3.15% interest from Varengold Bank in Germany.
Those looking to capitalize on the relatively high interest rates should do so promptly, as per FMH Financial Consulting, as conditions for fixed-term deposits are likely to continue to deteriorate - given that every anticipated key interest rate cut will push it further down. In the current environment, savers have the option to utilize the ladder strategy. This involves not keeping all savings on a single fixed-term deposit, but dividing it into different maturities across multiple accounts. This provides savers with flexibility, and they will not be tied down to long-term investments, for instance.
Highest Interest Rates
At present, according to FMH, the highest interest rate is offered by the German XTB at 4.215% (limited to three months). The Swedish TF Bank offers 3.762% fixed for three months.
Savings Accounts Compared
Installment Loans
While interest rates remain high for savers, consumer loans continue to be pricey. As long as fixed-term deposit interest rates remain elevated, consumer loans will not become significantly cheaper. This is unfortunate for consumers, as banks use fixed-term and savings deposits to fund consumer loans. In January 2022, the interest rate for a 60-month loan was approximately 3.70%, but by the end of 2022, it had risen to 5.95%. Currently, according to FMH, the average interest rate for this period is 7.28%.
However, it is worth comparing offers. The current range variates between 5.10 - 12.67%.
Installment Loans Compared
Mortgage Rates
Mortgage rates have roughly quadrupled since the beginning of 2022. According to FMH, the average interest rate for a 10-year loan is currently 3.38%, ranging from 3.02 to 4.20% per annum, depending on the provider.
The ECB's decision has an indirect impact on mortgage rates. The primary determinant is the yield on 10-year German federal bonds, as it largely influences the yields on covered bonds, which banks use to finance mortgage loans.
Max Herbst, the owner of FMH Financial Consulting, expresses his belief that homeowners may not necessarily need to pay less for their mortgages in the near future. "Individuals aiming to understand how mortgage rates will evolve should not focus on the key interest rate, but rather on the inflation rate. Since the ECB's role is to maintain the euro's stability, investors will factor in this possible future development, leading to acceptable yields on 10-year German federal bonds. The ECB's inflation target is around 2%, and this should be achieved in the long term. Consequently, the yield on German federal bonds will stabilize at slightly above 2.25% - slightly above the expected inflation target. If the yield on German federal bonds does not change significantly, the yields on covered bonds will also remain stable, and eventually, mortgage rates will not change significantly. This is not an encouraging outlook, considering the slight increase in property prices and relatively stable mortgage rates," Herbst mentioned.
If you're contemplating a longer or shorter lock-in period for interest rates, consider your predictions about future rate fluctuations. If you believe rates will drop substantially within the next five years, a shorter term might be preferable. Conversely, if you anticipate rising rates, a 20-year fixed rate could provide sensible security, albeit at a premium. The peace of mind it offers comes with a cost, but it guarantees stability in your financial obligations over the long term.
Evaluating Mortgage Rates
Overdraft Interest Rates on Savings Accounts
Account Comparison
Those with cash flow issues may occasionally dip into their overdraft limits to cover their expenses. However, this is generally not advisable, especially during periods of high interest rates. Even with interest rate reductions, overdraft interest rates usually stay high, as banks often set their rates based on the European Central Bank's main interest rate. Currently, the average overdraft interest rate is 12.02%, as per FMH, with an additional 13.35% interest for exceeding the overdraft limit. It's crucial to note that the overdraft linked to your savings account is usually the priciest loan a bank offers. Therefore, it should be used sparingly and for a brief time only.
Given the current decrease in the ECB's deposit rate, investors may consider shifting their funds from traditional savings accounts to investment opportunities, as the return on investment could potentially be higher.
The reduction in the deposit rate could also prompt banks to lower their mortgage interest rates, providing relief to homeowners with existing or upcoming mortgage payments.
