What is Euribor and 3 ways it affects you and the whole European economy

Euribor (European Interbank Offered Rate) is a central figure in the financial world, directly affecting the daily financial lives of millions of Europeans. It is not just an interest rate between banks, but the basis on which much of the euro area's variable rate lending is built, including home loans, business loans and leasing. Although Euribor may seem like an abstract financial term, its movements are directly linked to your monthly loan payments and affect the value and purchasing power of your money.

The aim of this article is to explain what Euribor is, how it works and why it plays such an important role in your personal finances. We give an overview of its impact and offer practical insights to help you make more informed financial decisions.

What is Euribor and how does it work?

Euribor or Euro Interbank Offered Rate is the lending rate between European banks. Imagine that banks are big shops selling money. Euribor is the price at which they buy and sell money from each other at wholesale. If this wholesale price changes, it will also affect the 'retail price', i.e. the interest rate on your home loan or other loan. The more money banks lend to each other, the more money they lend to you.

Euribor is actually several, denoting different time periods: 1 week, 1 month, 3 months, 6 months and 12 months Euribor. The most common home loans are linked to either the 6-month or 12-month Euribor. This means that the interest rate on your loan will be reviewed every six months or a year respectively.

The ECB and Euribor: who's leading whom?

The Euribor figure does not arise by itself. It is directly linked to European economic policies and, in particular, to the decisions of the European Central Bank (ECB). The ECB's main task is to keep the euro area inflation on a stable and long-term basis 2% level. To achieve this, the ECB uses a number of tools, the most important of which are. base rates regulation.

The Governing Council of the ECB meets regularly (about every six weeks) and decides on the base interest rates on the basis of in-depth economic analyses. If inflation is too high, as was the case in 2022, the ECB raises base rates. This will make it more expensive for banks to borrow money from the ECB, which will in turn force them to inter-mediate loans at higher rates. The result is a rise in Euribor. Conversely, if inflation slows and the economy needs to recover, the ECB may cut base rates, which will also lead to a fall in Euribor.

The Euribor is therefore not just a random number, but a direct reflection of the ECB's monetary policy and wider economic conditions.

How is Euribor actually calculated?

It is not just a simple arithmetic mean. In fact, 19 European banks give their daily quotes. to the European Monetary Institute (EMMI). The calculation excludes 15% from the highest and 15% from the lowest bids to avoid extreme data and ensure a more fair result. Final Euribor will be published every working day at 11.00 CET.

Negative Euribor

Euribor was negative between 2015 and 2022. The European Central Bank (ECB) implemented negative interest rates to stimulate the euro area economy after the 2008 financial crisis and the subsequent debt crisis. The aim was to encourage banks to lend rather than hold excess reserves, thereby stimulating spending, investment and inflation. This unconventional policy had significant consequences: while it reduced borrowing costs both for businesses and for borrowers of floating-rate loans such as home loans, it also lowered savings yields and undermined bank profitability. The era of negative Euribor ended when central banks started to raise interest rates to fight rising inflation, thus returning to a more conventional monetary policy.

History and lessons learned: why are we talking so much about it now?

The European economy has been through a significant cycle over the past decade, which has highlighted the movement of Euribor.

Euribor's sharp rise and the return of reality

However, 2009 brought a dramatic change. A sharp rise in inflation forced the ECB to embark on an aggressive campaign of interest rate hikes. This decision prompted a rapid rise in the Euribor, moving from negative territory to several percentage points on the plus side in a couple of years. The impact was painful for many.

A real example: Take Märtin, who bought an apartment with his family in 2021. He had a home loan of €150,000 with an interest rate of 6 months Euribor + 1.5% bank margin. At this point, Euribor was negative, which meant that his interest rate was around 1.5% and the monthly payment was very low. When Euribor rose above 4%, Märtin's interest rate on the loan increased to over 5.5% and his monthly payment increased by hundreds of euros. This unexpected extra cost forced the family to significantly revise their budget and put them in a much more precarious financial situation.

Borrower's dilemma: variable vs. fixed interest rates

Movements in the Euribor have led many borrowers to question whether it makes sense to choose a variable or fixed interest rate. This choice is one of the most important financial decisions to be made when taking out a loan.

Variable interest (Euribor + bank margin):

Pros: Historically, a variable interest rate is often more favourable than a fixed one. When Euribor is low, your monthly payment is also lower, leaving you with more spare cash. If interest rates fall, your payment will automatically decrease.
Cons: The main risk is uncertainty and volatility. If Euribor rises sharply, as it did recently, your monthly payment could also increase significantly. This assumes that your income can cope with a higher payment and that your risk tolerance is sufficiently high.

Fixed interest rate:

Pros: Stability and predictability. Your monthly payment will remain unchanged throughout the fixed period, regardless of fluctuations in Euribor. This provides security and makes it easier to plan your family budget.
Cons: The initial interest rate is usually higher than the variable rate. You don't benefit from a fall in interest rates and pay a higher price for stability. At the end of a long fixed period, you could face a higher interest rate if the market is at a lower level.

Practical advice: The choice depends on your risk tolerance and financial situation. It is always worth consulting your bank and asking for simulations of both options to see what your monthly payment would be at different Euribor levels.

How does Euribor affect investors?

Although Euribor is primarily discussed in the context of loans, it also has a significant but often underestimated impact on investors and the wider financial system. In fact, the Euribor is like an invisible thread that binds together different asset classes, from deposits to equities.

Deposits and bonds

The situation has changed dramatically after years of negative interest rates, with virtually no return on bank deposits. If the ECB raises interest rates and Euribor rises, banks will have to pay a higher price to borrow money, which will lead to higher interest rates. Deposit rates. This is of direct benefit to savers and conservative investors. Your money, which was sitting idle in your bank account, will now start earning again.

The same applies to bonds point. Bonds are essentially loans you make to governments or companies. The interest rate (or yield) on a bond is closely linked to the prevailing interest rates in the market. When Euribor rises, new bond issues give investors a higher yield, making them more attractive. At the same time, the price of lower-yielding bonds already issued may fall, as their yield is lower than the market's new opportunities.

Shares

The impact of the Euribor on the stock market is less direct, but still significant. Higher interest rates and more expensive borrowing have a direct impact on corporate activity.

Rising borrowing costs: Many companies, especially those operating in fast-growing and capital-intensive sectors, rely on loans to finance their business. As interest costs increase, their exposure to credit profitability, which in turn may make their shares less attractive. This is particularly critical for fast-growing but not yet profitable technology companies.
Changing investor behaviour: If bank deposits and bonds offer unexpectedly good and risk-free returns, more conservative investors may shift their money from equities to more stable financial instruments. This could reduce demand for shares and push down their prices. This is the so-called rotation of asset classes.

Real estate market

For real estate investors, Euribor movements are vital. Property is often bought with a high degree of leverage - meaning that a large part of the purchase price is covered by a loan.

Negative effects: When Euribor rises, the loan becomes more expensive and monthly repayments increase. This reduces the purchasing power of borrowers and makes it more difficult to buy property, which in turn reduces demand and can lead to a fall in property prices. Investors who already have loans will face higher costs, which will eat into their rental income or require higher out-of-pocket payments.
Positive impact: At the same time, a higher interest rate could boost the rental market. If borrowing becomes more expensive, many people will be forced to live in rented accommodation, which will boost rental demand and allow investors to charge higher rents. In the long run, however, this is a trade-off and investors need to carefully assess whether potential rental income can cover the increase in borrowing rates.

All in all, the Euribor is an important indicator that every investor should keep an eye on, as it provides valuable information on macroeconomic trends and offers clues as to which asset classes might be more attractive.

Foresight and risk management

The European Central Bank's target is to bring inflation to 2%, which is also the key indicator for the future path of Euribor. Forecasts are in a constant state of flux, but it is important to understand that the Euribor is unlikely to return to its long-term negative levels. This era was the exception, not the rule. More stable, but still positive, interest rates are expected in the future.

What can everyone do?

Create a buffer: If you have a variable interest rate, think about whether your family's budget can cope if your loan payment increases 20-30%. Create a savings buffer to help cope with the extra costs of unexpected interest rate rises.
Ask for advice: Follow the ECB's press conferences and Eesti Pank's analysis. Don't make important financial decisions based on emotion, but on analysis and expert advice.

Contact the bank: If you feel your loan payments are too high, talk to your bank. Flexible solutions, such as extending the repayment period, are often available.

Summary

Passive income is not a myth, but it is not free either. It requires time, money and discipline at the start. The most important thing is to understand that it is a long-term strategy. By starting early, your 'money tree' will grow large and fruitful over time, giving you financial freedom and choice in the future.

In the next article, we will delve into the world of active income and explore how to make the most of your main source of income to build a strong foundation for both passive and active income growth.