What are the ECB key interest rates and what are they used for?
What is an interest rate?
Interest is what you pay for the money you borrow. It is also what you receive for the money you save (as you “lend” your savings to the bank).
The annual interest rate indicates the amount you must pay or receive after one year as a percentage of the total amount that you borrowed or lent.
What are the key interest rates?
The key interest rates are the interest rates banks pay to borrow from the ECB or earn on their deposits at the central bank.
At present, the most important rate is called the “interest rate on the deposit facility”. This rate is one of the three interest rates the Governing Council sets every six weeks. The other two are the rate on the main refinancing operations and the rate on the marginal lending facility.
How do they affect the economy?
Under normal conditions, the ECB sets the level of the key interest rates in order to influence various other interest rates in the economy. This is the ECB’s main tool to indirectly influence prices and keep inflation at 2% over the medium term.
When the ECB changes the key interest rates, commercial banks usually change the interest rates on the loans and deposits they offer their customers.
If interest rates drop, borrowing becomes cheaper and saving less attractive. This encourages households and firms to consume and invest more. As a result, the economy is stimulated and the prices of goods and services tend to rise more.
Changes in interest rates also pass through other channels of the economy. This process is complex and takes time.
To achieve its inflation target, the ECB has to assess how much households and firms plan to consume and invest, given the current and expected level of interest rates. If consumption and investment need to be encouraged in order for inflation to increase, the ECB normally lowers interest rates. On the other hand, if inflation needs to be reduced, the ECB normally raises interest rates.
Why are interest rates important for citizens?
A change in interest rates can have a major impact on our lives, even if this change is small and the rates are low.
Whether we have loans or savings, it is important to understand how a change in interest rates can affect our household or firm. Such a change may affect:
- monthly charges on loans to buy a house or car;
- a firm’s charges on a loan to invest in new equipment;
- interest earned on savings.
