The Interest rate Cycle and what it entails?

Each phase of the interest rate cycle has its own side effects, causes its own turbulence. In today’s era we have entered a sharp upward phase. What does this upward phase entail?

Until recently, a company with a high rating could borrow at an interest rate equal to euribor (which in practice was zero) plus 3-3.5%. Now that the euribor is hovering around 2.5%, the cost of borrowing to businesses has jumped to 5.5%-6% respectively. A company, for example, that had 20 million euros in loans with an interest rate of 3.5%, paid 700,000 euros in interest. Now for the same loans, with an interest rate of 6%, he has to pay 1.2 million euros in interest. On the other hand, the increase in interest rates is generalized but not so generalized as to apply to all banking products. Usually, some banks in some member countries do not apply this interest rate increase to deposits made with them.

The increase in the ECB’s interest rate by 0.75% at the October meeting has almost been discounted, while the scenarios also speak of another corresponding increase by the end of the year. The possibility that the key European interest rate could even be above 3% in the first half of 2023 is a possibility, which should be considered by households and businesses as part of their forecasting exercises. their loan installments.

So, if the company in question has some millions of euros in deposits, these do not bring it any profit. If, however, he deposits these heads, for example, in some private-banking in London or Luxembourg he can collect a return of 0.60% for a month’s term and more than 2% for a year’s term deposit. If things continue like this and banks continue to keep all the profit from rising interest rates and give nothing or little to depositors, there will be a risk of deposit leakage.

In addition to businesses, the sharp rise in interest rates also causes major to insurmountable problems for thousands of households, especially those with weaker incomes, which the energy economic crisis found burdened with a recent housing loan, with an Euribor or ECB interest rate.

As a general rule, the first half of a mortgage’s term is mainly interest paid, and the second half is principal. In the case of a 25-year mortgage, those who took it before 2005 will not be charged, but later borrowers will suffer more or less. This will be a problem that will be added to what is already plaguing wider sections of European societies, while the most vulnerable households are at risk of “bending”.

The statistics also show it. In four of the 27 EU member states, the population at risk of poverty has increased and income inequalities are widening. Summarizing:

1. Because of the sharp upward phase of the interest rate cycle, there is a risk on the horizon of great suffering for businesses and households and an increase in bad loans – something that until today appeared to be a pressing, but nevertheless manageable problem.

2. The possibilities of state (fiscal) support are in question, because in the previous two years an incredible unthinkable amount was distributed, in a relaxed, clientelistic and horizontal way (eg Greece, Italy) without strict criteria of justice and development. Thus, in the second round of state aid there is weakness.

3. Banks, due to their unexpected income from the increase in interest rates have the possibility to shield themselves by passing additional provisions against new risks. The issue is what the banks will do for the societies and economies of their member countries.