How a paradigm shift in interest rates and expectations is reshaping the Eurozone’s financial landscape

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Tamaz Georgadze, Chief Executive Officer, Raisin, Max von Bismarck, Chief Business Officer and Managing Director, Raisin

• Financial landscapes across the world have recently shifted in response to central banks’ monetary policy changes.
• The appeal of traditional savings products has surged amid the Eurozone’s fastest interest rate hiking cycle in history.
• Here we explain the implications of interest rate changes and their implications on savings and financial stability.

The global and European financial landscapes alike have recently witnessed notable shifts in response to central banks’ monetary policy changes. The allure of traditional savings products, such as overnight and fixed-term deposits, has surged amid the Eurozone’s fastest interest rate hiking cycle in history.

So what are the implications of interest rate changes and their implications on savings products and financial stability?

DISCOVER

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Bank deposits stand as the bedrock of the global financial system, playing an indispensable role in its seamless operation. The total global household financial assets, encompassing both deposits and investments, have reached an impressive $150 trillion, with a consistent 7% compound annual growth rate.

Deposits, constituting approximately one-third of households’ financial assets, hold a pivotal position as a stable and foundational asset class.

These deposits remain resilient, characterized by shifts primarily between non-interest-bearing and interest-bearing accounts. Indeed, a significant portion of total bank funding, approximately 60%, stems from deposits, with households contributing around 40% to this vital funding source.

Household financial asset allocation in Europe Image: European Central Bank and Raisin Banking Analytics

Particularly noteworthy is the fact that, during periods of elevated interest rates, deposits emerge as an economically favourable funding option. In the ongoing economic cycle within the European Union (EU), deposit betas exhibit a substantial decrease compared to past cycles, rendering deposit funding even more appealing.

In essence, deposits serve as the lifeblood of the financial system globally, providing stability, liquidity and a fundamental basis for economic activities. Their resilience, coupled with their significant contribution to bank funding, underscores the central role they play in ensuring the robust functioning of the financial ecosystem across the world.

Interest rate dynamics and the impact on savers

In a historic turn of events, the year unfolded with the Eurozone witnessing the swiftest escalation in interest rates ever recorded, orchestrated by the European Central Bank (ECB).

Interest rates on deposit facilities reached a pinnacle, now stabilised at 4.00% following an unbroken sequence of 10 consecutive hikes, as visually depicted below. These hikes led to the highest interest rate levels in the last two decades.

Cumulative rate hikes since start of cycles, in bps Image: European Central Bank and Raisin Banking Analytics

The reasoning behind this series of rate hikes finds its roots in a multifaceted array of factors, with a paramount focus on the pivotal role they play in combating inflation.

The aftermath of the global pandemic has ushered in an era marked by a surge in inflation rates, prompting the ECB, in alignment with central banks worldwide, to strategically deploy interest rates as a formidable tool to counterbalance and mitigate the upward trajectory of inflationary pressures.

This rapid succession of rate hikes has naturally prompted savers to rightfully ask the question: “When will the interest I receive on my savings reach its peak?”

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The ripple effect of elevated interest rates casts a shadow over consumers, amplifying the financial strain as mortgages and the interest burden on various loans soar, ushering in an era of heightened expenses.

Compounding this financial challenge, the escalated cost of doing business, a direct consequence of soaring interest rates, invariably trickles down to consumers, compelling them to bear the brunt of inflated prices for their everyday necessities.

This intricate interplay of economic forces intertwines with the burgeoning cost of living crisis, exerting its influence across the European landscape, impacting the lives of individuals in myriad ways. Conversely, when interest rates take a downward plunge, a diametrically opposed scenario unfolds, breathing life into an expanding economy.

Navigating this economic terrain is the ECB. Convening eight times annually, at six-week intervals, in what is known as the Governing Council monetary policy meeting, the ECB determines the course of interest rates, wielding a profound influence on the economic trajectory and the financial well-being of millions across the Eurozone.

As a result of these interest rate hikes, retail depositors are gravitating towards fixed-term deposits, reallocating more than €250 billion in the first half of 2023 alone.

In the Eurozone, the appeal of classic savings products, particularly term deposits, has seen a substantial uplift, with an increase of 38% equating to an additional €400 billion in 2023. Germany leads this surge, contributing €194 billion to the growth.

Outstanding Euro area retail deposits (% of total) and retail deposit net flows in €bn, total Euro area. Image: European Central Bank and Raisin Banking Analytics

This significant shift in preferences underscores the evolving dynamics of the financial market.

In the midst of frequent fluctuations in the interest rate market, a pressing question on the minds of many savers arises: how can one prepare for potential drops in interest rates? The dynamic nature of the interest rate landscape underscores the importance, now more than ever, for consumers to optimize the returns on their cash.

It has become paramount for savers to lock in and take advantage of the high interest rate environment whilst it persists. Especially given that we are at the peak of the hiking cycle and current data shows that the market’s expectations are to see at least five interest rate cuts before the end of the year across the EU, UK and the US.

An effective method of doing so is the utilization of fixed term deposits with a longer duration, which have demonstrated their value as a means for customers to secure a predetermined interest rate for a specific period of time.

This approach proves particularly advantageous during periods marked by elevated interest rates, allowing savers to capitalize on the current rate environment and safeguard their financial interests whilst still gaining the insurance of deposit guarantee schemes.