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Effect of monetary policy takes time to materialise and varies by country


In October the ECB did not raise its rates for the first time since the summer of 2022. This does not mean that the effects of tighter monetary policy have already worn off, however.

Published: 20 November 2023

Echtpaar kijkt naar ruit tekoop woningen hypotheekverstrekker

The sharp interest rate increases implemented between July 2022 and September this year are still to have their full impact on the economy. The extent to which this happens varies greatly between euro area countries. For example, Finnish households are more interest rate-sensitive than Dutch households, which have fixed their mortgage interest rates for much longer.

ECB interest rate hikes pass through financial markets and banks to households and businesses

To curb inflation, the ECB rapidly and sharply raised its policy rate to 4% in 14 months. The policy rate is the rate at which banks can deposit money with the ECB. Policy rate adjustments do not immediately affect economic activity and inflation. This is because financial markets and banks respond to ECB policy rate adjustments, which in turn affects the interest that governments, businesses and households pay and receive. Higher rates make borrowing more expensive and saving more attractive, which means that households and businesses borrow and spend less money, ultimately pushing inflation down. This is known as “monetary transmission”.

The ECB steers short-term money market rates by setting the rate at which banks can borrow and deposit money. This first step of transmission happens relatively fast. Expectations about future monetary policy also affect medium and long-term market interest rates. In turn, banks base the interest rates they charge on these market rates. On average in the euro area, it takes six months to a year for changes in market interest rates to be largely reflected in interest rates on new bank loans. Savings rates generally adjust more slowly.

Interest rates on new loans in the Netherlands began to rise as early as spring 2022, a few months before the ECB raised its rates for the first time. This was mostly the case for long-term loans, such as mortgage loans. This was because the purchase programmes were discontinued and market participants already anticipated the future interest rate hikes. Subsequently, rates on new loans with shorter maturities also rose sharply over a short period of time. The higher rates on new loans have strongly depressed demand for new household and business loans, Dutch banks indicate in the Bank Lending Survey. This is precisely the goal of the ECB's higher policy rates, as this also reduces investment, cools the overheated economy and ultimately pushes inflation down.

Interest rates on existing loans are rising slowly

So while interest rates on new loans have risen quickly, not everyone feels the impact of higher rates right away. Most household and business loans have rates that are fixed for a certain period. This means the average interest rate on all existing loans is rising only slowly, because only new loans carry higher rates (see Figure 1). Interest on the loans that have longer fixed-term periods will not go up until their interest rate reset date.


Interest rates (%)


Source: ECB MIR.

So the pace at which higher interest rates feed through to the economy depends in part on the fixed-rate periods of existing loans. This varies widely across countries. Figure 2 shows for each euro area country the percentage of households with a mortgage loan and the share of households facing an interest rate reset within the next 12 months. A notable feature is that while relatively many Dutch households have a mortgage loan (60%), a mere 6% faces an interest rate reset within the next 12 months. By contrast, 40 % of Finnish households have a mortgage loan, with 90 % of which facing a reset within the next 12 months. This makes households in Finland more interest-rate sensitive. That said, households looking to take out a new mortgage loan are very likely to be facing higher rates, including in the Netherlands.

Mortgage loans subject to interest rate reset within the next year


Source: Eurostat; BSI

In business investment, too, the ratio between short-term and long-term financing affects the pace of monetary transmission. In the euro area, bank lending is a major source of debt financing, at around 75%. Of these bank loans, 18% will mature over the next 12 months. This means any roll-overs will be at higher interest rates. This puts a drag on investment, dampening the economy and pushing inflation down.

The full impact of higher interest rates on inflation has yet to materialise

It takes time for interest rate increases to move through the economy because only a portion of households and businesses are immediately affected by higher bank rates. This is why the total impact of the most recent interest rate hikes on the economy and inflation is not yet visible. The ECB therefore bases its decision-making on medium-term inflation expectations. Currently, the transmission to the economy is expected to continue in the period ahead, which is why the ECB decided to pause interest rate hikes in October.

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