The ECB’s key interest rate: what it is and how it affects you

Across Europe, prices for energy, groceries, and services are rising. According to Eurostat, the annual inflation rate has increased to 9.9% in the eurozone—a new record high. And in response, the European Central Bank (ECB) raised the key interest rate in July 2022 for the first time in 11 years—and then raised them again several time until September 2023. The goal: to counteract the devaluation of the euro and to give consumers some relief.

But what exactly is the ECB’s key interest rate? How high is it currently? And what does the ECB’s interest rate hike mean for your savings goals and future plans? Read on to get answers to these questions and more.

The key interest rate is a fixed interest rate. It determines the conditions when commercial banks borrow money from or invest money with central banks. It’s used to influence the financial market, and it’s one of the most important tools for managing inflation and currency exchange rates. In general, low key interest rates stimulate the economy, while higher interest rates tend to slow it down.

Within the eurozone, the key interest rate is set by the ECB. Although we often talk of a single "key interest rate," the ECB actually has three:

• Main refinancing rate: This is the interest rate for commercial banks borrowing money from the ECB in the medium term.
• Marginal lending rate: This is the interest rate for commercial banks borrowing money from the ECB in the short term.
• Deposit interest rate: This accrues when banks store their excess money at the central bank overnight.

Each of these three interest rates has different functions. Therefore, they affect consumers, savers, and investors in different ways—let's take a closer look.

The main refinancing rate is the top lending rate. When people talk about the "ECB’s key interest rate," this is usually what they’re referring to. It specifies the conditions under which commercial banks can borrow money from the ECB in the medium term (between two weeks and three months).

When the main refinancing rate is low, European commercial banks can offer their customers low interest rates on loans because they are able to borrow money cheaply from the ECB themselves. However, when the key interest rate is low, the interest on savings is also low. That’s particularly tough for those who want to save money. When the key interest rate is high, the exact opposite is the case: Loans become more expensive, but interest on savings increases.

The marginal lending rate is the interest rate at which commercial banks can borrow money from the ECB in the short term (e.g. overnight). It’s usually higher than the main refinancing rate. A low marginal lending rate drives inflation, while a higher marginal lending rate can slow it down.

The deposit interest rate, also known as the deposit facility, is the interest on overnight deposits. It’s the opposite of the marginal lending rate, and accrues when banks store their excess money overnight with the central bank. The deposit facility is always below the main refinancing rate.

The deposit interest rate has been negative since 2014, but in July 2022 the ECB raised it to 0%. This means that banks no longer have to pay fees if they deposit their excess money into the central bank. The deposit interest rate has a direct impact on instant-access savings accounts or checking accounts that accrue interest. To compensate for the ECB’s negative deposit interest rate, many banks demanded a custody fee from customers who had more than €25,000 in their account. But now that the deposit interest rate is back up to zero, there should soon be an end to the custody fee.

Since July 2022, the ECB raised all three key interest rates ten times, with an accumulate increase of 4 points Before July 2022, the last time that key interest rates were raised was eleven years ago. Since March 2016, the main refinancing rate has been exactly 0% and the marginal lending rate has been 0.25%. The deposit interest rate has been -0.5% since 2019—and it’s been in the negative for even longer than that, since 2014.

With the recent interest rate hike by the ECB, here’s where the three key interest rates stand now:

• Main refinancing rate: 4,50%
• Marginal lending rate: 4,75% 
• Deposit interest rate: 4,00%

So, that’s what the different rates are and where they’re at today. But how exactly does the key interest rate work in practice? And what effects do low or high key interest rates have on consumer prices?

The ECB can raise or lower interest rates to steer price developments. The key interest rate has a direct influence on the money supply on the market, which in turn influences consumer prices. For example, a low interest rate leads to a larger money supply and accelerates the circulation of money. In this situation, every euro is worth less and inflation increases. Conversely, a higher interest rate can slow down inflation. With less money available on the market, every single euro increases in value. Consumer prices fall and, therefore, inflation decreases.

When the key interest rate rises, it becomes more expensive for banks to borrow money from a central bank. In order to offset these costs, banks then charge more for the loans they offer. As a result, customers take out fewer loans. In addition, banks borrow less money from central banks, so the supply of money decreases. As a result, every existing euro increases in value and consumer prices become cheaper.

Wonder why this works? Basically, it’s about how people use their money. When the key interest rate is high, the interest on savings also rises—so it's a good time to save. Consumers start to spend less, preferring to save instead. By spending less money, demand for products falls, which causes prices to do the same. The economy slows down, companies make fewer investments, and inflation falls. Think of a high interest rate like a brake pedal for the economy.

A low interest rate means that banks can borrow money more cheaply from a central bank. In turn, banks can also offer their customers better interest rates on loans. However, with a low key interest rate, interest on savings also falls. In this situation, many consumers and companies prefer to spend their money, since they don’t see it as worthwhile to keep it in their savings accounts. This behavior stimulates the economy and increases demand, and companies make more investments, hiring more staff and paying higher wages. The increasing demand for money fuels economic growth and stimulates the stock market. As a result, however, consumer prices also rise and every euro is worth a little less. The low key interest rate is like an accelerator for the economy—but can also drive up inflation.

​​Put simply, the ECB is responsible for managing the euro and executing monetary and economic policies in the euro area. The Governing Council of the ECB is therefore often referred to as the currency’s watchdog. Among the main tasks of the ECB are:

• determining and implementing monetary policy in the euro area
• conducting foreign exchange operations
• holding and managing the official currency reserves of EU member states 
• promoting the smooth operation of payment systems
• directly supervising the largest banks in the euro area, including granting and revoking banking licenses
• issuing banknotes within the eurozone
• providing the central bank balance sheet
• advising national authorities and cooperating with national and international organizations
• gathering and providing statistics
• maintaining financial stability and macroprudential policy 

With its monetary policy, the ECB is aiming for a 2% inflation rate in the medium term. In other words, it’s trying to keep inflation (i.e. the rate of price increases for consumers) at a stable level. For the ECB, an inflation rate that’s too low is just as negative as one that’s too high. Why? Because its central goal is to ensure price stability and preserve the value of the euro. Through price stability, the ECB contributes to economic growth and the creation of new jobs.

Since the 2008 financial crisis, the ECB has gradually lowered the key interest rate to 0% in order to promote economic growth. Even during the coronavirus pandemic, a low key interest rate was meant to boost the economy. For most of the past decade, inflation in the euro area was below the ECB's target of 2%.

However, both Russia's aggressive war in Ukraine and the related energy crisis have fueled inflation since early 2022. In the euro area, the inflation rate reached 9.9% in June 2022—five times the ECB’s target. To hit the brakes and slow down inflation, the ECB has now taken restrictive measures like raising the key interest rate. As the ECB reduces the amount of money in circulation by raising interest rates, the value of the euro increases. And because there’s a strong incentive to save money, consumers spend less, which reduces demand—leading to lower consumer prices and lower inflation.

The ECB raises the key interest rate whenever consumer prices are rising too steeply. The inflation rate in the euro area is currently at a high level: In Germany, for example, it was 10.0% in September 2022 and in Austria it was even higher, at 10.5%.  

Although the ECB can’t do anything about the root causes of inflation, its interest rate hike ensures that at least the increase in prices is slowed down. After all, its goal is to avoid a permanently high inflation rate. If that happens and the cost of living rises significantly overall, then there’s a risk of a so-called wage-price spiral, which could cause inflation to spin out of control and, in extreme cases, turn into hyperinflation.

Source: Key ECB interest

Clearly, the rising interest rate is very complex. But what does the increase mean for you and your future plans? To break it down for you, we’ve summarized the important facts about the key interest rate and how it affects your savings, investments, consumption, and the real estate market. 

For savers, the increase of the interest rate might actually be good news, since it marks the end of negative interest rates. Other fees you used to pay, such as for holding a certain amount of money in your account, will probably be canceled in the upcoming months. Plus, your saving interest rate should slowly increase just like the key interest rate did. But since the inflation rate is still pretty high, it’s possible that the real interest rate will remain in the negative for the time being. At the very least, higher interest rates will help slow down inflation as well as securing the worth of your savings.

The increase of the interest rate is not only supposed to slow down inflation, but also release pressure on low-income households. It’s meant to reduce the amount of money in circulation and to motivate consumers to save their cash instead of spending it on goods or services. This should result in decreased demand and a drop in prices for consumers. 

Dreaming of your very own home? Unfortunately, the ECB key interest rate increase negatively affects loans. For the next while, it’s going to be a lot harder to find real estate loans with low interest rates. If you’re already paying back a real estate loan with flexible interest rates, you may pay more as well. 

But don’t be too discouraged. If the ECB’s strategy works, real estate prices will begin to drop again. For now, it's probably best to only buy a house or flat if you're intending to live there yourself—and if you have enough proprietary capital. Better to start saving sooner rather than later.

To protect your money from any negative consequences of inflation, you could invest it in ETFs, stocks, or a flat. In the current circumstances, those options might be more likely to be profitable investments. After the ECB key interest increase, most bond ETFs will probably be in the red before they climb back up into positive territory. Stocks or cryptocurrencies are even more risky right now. If you have money saved up that you won’t need to access in the next few years, a fixed-term deposit account might be a good idea, since those usually offer better interest rates. But also a day-to-day account offers attractive interest rates, which helps you to utilize your money—without giving up financial flexibility.

For bank customers with higher saving deposits, the increase of the key interest rate is good news. It could soon put an end to deposit fees that you have to pay if your account balance is above a certain threshold. This goes back to what we mentioned earlier: The deposit facility is now at 0%, and the ECB isn’t charging fees when banks deposit money with them above a certain amount. As a result, most banks have already eliminated their negative interest rates or have raised the limit for deposits which would have otherwise incurred a fee.

While many banks are still hesitant to react, N26 already completely abolished the deposit fee. Previously, N26 customers were charged a yearly deposit fee of 0.5% if their account balance was above the €50,000 threshold. This was already eliminated in July 2022.

However, if you use an overdraft facility, you should take a close look at it. The changes in the ECB’s key interest rate can also affect the interest rate on your overdraft facility. The overdraft facility at N26 is 8.9% above the main refinancing rate of the European Central Bank.

Of course, you can cancel your N26 overdraft facility at any time in your app. Just make sure to deposit enough money into your account first so that your balance isn’t left in the negative, otherwise you could incur fees.