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ECB interest rate hikes have a higher pass-through to mortgage than to savings rates
Published: 10 May 2023
While interest rates on mortgages have risen sharply following the ECB's recent rate hikes, the increase of interest rates on savings accounts has been limited so far. Banks do not pass on an ECB rate hike equally to their customers as they wish to maintain their interest margin. This was also the case in previous periods of interest rate hikes. This has emerged from an analysis (only in Dutch) by economists at De Nederlandsche Bank (DNB).
Banks pass on ECB interest rate hikes
Globally, but certainly also in the Netherlands and the euro area, inflation rose to unprecedented levels due to soaring demand for goods and services following the loosening of pandemic-related measures and sharply higher energy prices.
In response – and with the expectation that inflation will remain elevated for too long – the ECB raised the key policy rate in seven large steps from -0.5% in July 2022 to 3.25% in May 2023. These measures, together with the ECB's balance sheet reduction, are aimed at bringing back inflation towards the 2% target in the medium term.
Financial markets and banks respond to ECB policy rate adjustments, which in turn affects the interest that governments, businesses and households pay and receive. This makes borrowing more expensive and saving more attractive, which causes households and businesses to spend less money, thus helping to bring inflation down. This is known as “monetary transmission”.
Interest rates on savings rise slower than lending rates
Interest rates on savings generally adjust more slowly than interest rates on loans, including mortgages. This is because banks charge higher interest rates only on new loans or variable rate loans. The interest on existing fixed-rate loans remains unchanged. A rise in interest rates therefore only partially affects banks’ loan portfolios and thus their interest income. In contrast, deposits tend to have variable interest rates. A higher interest rate on savings therefore directly affects (nearly) all deposits and thus banks’ funding costs.
To maintain the interest margin on all loans and savings, interest rates on loans must rise faster than interest rates on (nearly all) savings. When setting these rates, banks are faced with a trade-off between raising rates on savings immediately when the policy rate rises, which erodes interest margins, or deferring rate hikes, which may cause customers to shop around and potentially withdraw their deposits. This is called the deposit channel of monetary policy, and explains why banks do not immediately raise rates on savings when the ECB raises the policy rate.
Somewhat quicker and higher pass-through to savings rates this time
The last time the ECB raised interest rates several times in a row was in 2005-2007, when rates rose to 4% in eight equal steps.
The transmission from policy rates to interest rates on savings was incomplete between 2005 and 2007. Figure 1 shows that two years after the first policy rate increase, the average savings rate for households in the Netherlands eventually rose by almost 40 basis points (0.4 percentage points). The policy rate rose 200 basis points during that period. This means that the pass-through in the Netherlands was only about 20%. Additionally during this period, it took about four months after the first policy rate hike before interest rates on savings started to rise.
Although only eight months of data, measured from the first policy rate hike, are available for the current cycle, we see that the pass-through is limited, as was the case at the early stages of the tightening cycle in 2005-2007. In March 2023, the pass-through to the average savings rate for Dutch households was 15%, which is slightly higher than the pass-through of 9% eight months after the first interest rate hike in 2005. Interest rates on savings have recently risen a bit more promptly in response to the policy rate hike than in the 2005-2007 period. One reason for this is that the first interest rate hike meant an end to the negative policy rate, and many banks rather quickly passed this rate increases on to customers previously holding saving accounts with negative interest rates.
Pass-through of higher bond yields to rates on new mortgage loans already nearly 65%
The pass-through of policy rates to mortgage interest rates (on new mortgage loans) is faster and more complete than for interest rates on savings. Since mortgage rates are largely determined by bond yields (on 10-year government bonds), we compare these to determine the pass-through. Bond yields are partly driven by expectations about monetary policy, which are influenced in part by the ECB’s communication on future monetary policy. This is indeed evidenced by the rise in bond yields months before the first policy rate hike.
In the current cycle, bond yields rose earlier prior to the first official rate hike than they did in 2005-2007, see Figure 2. This earlier rise coincided with the ECB’s December 2021 decision, when it announced the discontinuation of net bond purchases (quantitative easing - QE). QE was not a factor in the previous cycle, and its termination is one of the explanations for the more rapid rise in bond yields and related mortgage rates currently.
In 2005-2007, the rise in bond yields finally worked its way almost entirely (around 80%) into mortgage interest rates on new loans. At the moment, this pass-through rate is nearly 65% in the Netherlands. When taking out a new mortgage loan, households are thus likely to face higher mortgage rates. However, most homeowners are currently still paying relatively low mortgage rates, having taken out mortgage loans with long fixed-rate terms, sometimes of up to 20 years, before the current tightening cycle.
Differences from 2005-2007
In this cycle, the final transmission of policy rates to interest rates on mortgages and savings may be different from 2005-2007. Policy rates have now risen much faster, for instance, there was no reduction of the central bank balance sheet (which affects bond yields) in 2005-2007, and policy rates were still negative prior to July 2022. This put pressure on banks’ interest margins. Banks may try to mitigate the impact of this pressure by adjusting mortgage interest rates faster than interest rates on savings. In addition, the savings balances of Dutch households have increased on average especially during the COVID-19 pandemic. Partly because of this, banks currently have relatively ample liquidity, also because central banks have provided wider funding opportunities. This gives Dutch banks scope to adjust interest rates on savings slowly.
The influence of these factors on further transmission to interest rates on mortgages and savings remains difficult to determine for now. However, we can conclude that the lag in the pass-through to interest rates on savings compared to mortgage interest rates is not unusual.
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