Credit market: what will happen after the interest rate increase?

For the first time since July 2008, the EurCen Bank (EB) raised the key rate for the euro zone on Thursday. As expected, the minimum bid rate increased by 25 basis points. Borrowers should follow the move as closely as the statements by EB President Jean Claude Trichet at the press conference.

The interest rate increase was expected in the financial markets.

The interest rate increase was expected in the financial markets.

In the first instance, it will affect the interest rates of variable-rate loans and short-term installment loans. In particular, the borrowing costs of disposition and credit lines are often linked to the EB interest rate, so that an increase is expected for the next month or quarter.

With regard to future financing projects, Thursday’s interest rate move is less important than the guidance given by EB President Jean Claude Trichet at the press conference on monetary policy. Central banks are clueless and have their plans interspersed between the lines. That was also the case this time.

Trichet spoke of “upside-down” inflation risks.

Trichet spoke of "upside-down" inflation risks.

According to the statutes, inflation control is the most important task of the EB. If the central bank sees growing risks for price-level stability, this is an indication of further interest-rate hikes. Trichet said in this regard that the central bank would “very accurately” track inflation risks. This in turn means that the next date for an interest rate increase has not yet been determined.

Trichet stated that there was no decision on a series of interest rate increases. Overall, this can be interpreted in such a way that until the summer months there will initially be no further increase in the key interest rate. If the EB’s inflation target (an inflation rate just under two percent per annum) is still under threat, further tightening will follow.

The interest rate curve on the money market indicates that market participants are expecting two further interest rate hikes of 25 basis points each. It probably will not be much more. The EB confirmed very clearly that it would not accept inflation rates of more than 2% per annum. In view of the removal of inflation from the monetary authorities’ target, the very cautious rate hike alone can be interpreted as indicating that, at least for the time being, the stabilization of the fragile economy is in fact taking precedence.

Anyone planning a major purchase should therefore not be rushed – the interest will in all likelihood not rise drastically in the near future. Nevertheless, it may be worthwhile to install installment loans or real estate loans now – loans will never be cheaper.

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