The ECB has raised interest rates sharply since July 2022. What does this mean for you?

Against the backdrop of soaring inflation in the wake of the pandemic and the war in Ukraine, the European Central Bank (ECB) started raising its three key interest rates in July 2022. For more information on the ECB’s latest (interest rate and other) decisions, please visit its website.

Why has the ECB raised interest rates?

In its capacity as the central bank for the euro area, the ECB is mandated to maintain price stability. When prices in the economy are rising too fast (in other words, when inflation is too high), raising interest rates helps bring inflation back down to the 2% target rate over the medium term.

Inflation is putting a strain on people. Many are worried that it is here to stay. The ECB keeps an eye on these so-called inflation expectations. That’s why it has raised interest rates: to send the message that it will not allow inflation to stay above 2%. That will help keep inflation expectations in check.

What causes interest rates to move?

The interest rates that banks offer people and businesses usually move in tandem with the rates set by the ECB, but they are also influenced by other factors. In a free market economy like the euro area, rates are also determined by the demand for and supply of credit. In other words, how much businesses and people want to spend and invest, and how much credit is available.

What is the ECB’s role?

The ECB is the central bank for the euro. It is not the ECB that sets the interest rates that you pay on your loan or receive on your deposit. But it does influence them.

interest rates

It is the European Central Bank that sets what we call the key interest rates or “policy” interest rates. These are the rates it offers banks that want to borrow from it and for the electronic money they keep with the ECB overnight.

When the ECB changes the key interest rates, this is reflected to a greater or lesser extent across the entire economy, including in bank loans, market loans, mortgages, bank deposit rates and other investment instruments.

What is the NBB’s role?

The National Bank of Belgium is our country’s central bank. Since the launch of the euro, it has been part of the Eurosystem, along with the ECB and all the other central banks of the countries that adopted the single currency. The ECB, in turn, is the central bank for the euro and its job is to keep prices stable. The Governor of the NBB, as well as his opposite numbers from Eurosystem countries, sits on the ECB’s Governing Council, which analyses the economic situation in the euro area roughly every six weeks and examines these key interest rates. So, the National Bank contributes to monetary policy-setting, one of the essential tasks of a central bank.

How do the key interest rates affect inflation?

In normal times, if inflation is too high because of too much demand chasing too few goods and services, the ECB can raise rates to make credit more expensive. This will cool the economy, calm inflation expectations and bring inflation down.

If inflation is too low – which was the case for a long time – the ECB can lower rates and make credit cheaper to boost investment and demand.

Since the post-pandemic reopening of the economy and the outbreak of hostilities in Ukraine, inflation has risen rapidly and is now considered too high. Prices have increased a lot owing to the war, especially for energy and food. Many companies are also finding it more difficult to get the materials, spare parts and workers they need for production, which is worsening problems that were already there because of the pandemic.

Raising interest rates alone will not solve all these problems. Higher interest rates will not make imported energy cheaper, stack empty shelves in supermarkets or deliver semiconductors to car manufacturers.

Higher rates keep inflation expectations under control

What higher rates will do, though, is keep inflation expectations under control. If people and businesses think high inflation is here to stay, workers are likely to demand higher wages and employers may in turn put up their own prices. This is often referred to as a wage-price spiral. The ECB will keep raising interest rates — making credit more expensive and savings better rewarded — to prevent such a spiral. It will make sure businesses, workers and investors are confident that inflation will come down to 2% over the medium term. The ECB will not let expectations of higher inflation become entrenched.