Low interest rates

WHAT DOES "LOW INTEREST RATES" REALLY MEAN?

The term low interest rates means the interest rates or the national interest rate level. The central banks set the level of interest rates worldwide, and in Europe this is done by the ECB. The key interest rates are the basis for the development of credit and investment interest. Banks are guided by the requirements of the central bank in interbank trading and in their customer conditions. Money market rates determine the interest rate development of short-term loans and investments. Capital market interest rates are crucial for the direction of medium to long-term interest rates. Inflation expectations are also included in long-term interest rates. Creditworthy first-class debtors currently pay zero interest or may even collect negative interest.

WHERE DID THE LOW LEVEL COME FROM?

The key interest rates serve the monetary control of an economy, the amount of which determines the circulating money supply, which in turn influences the inflation rate. Banks refinance themselves at the central bank by lending money to them. There are three key interest rates, the main interest rate is the main refinancing rate, which is called the actual policy rate. The main refinancing rate serves as the reference interest rate for short-term bank deposits such as savings, daily, term and short-term time deposits. If the ECB raises the key interest rate, the refinancing costs for the commercial banks become more expensive. If the central bank lowers the key interest rate, the costs of procuring liquidity from banking institutions are reduced.

The central banks are trying to stimulate or slow down the economy of their economic area by changing interest rates. If borrowing rates are lowered, theoretically more companies and individuals are willing and able to get into debt and finance new projects and products. The extent and duration of the global economic, banking and financial crisis have forced massive cuts in interest rates since 2008 in order to stimulate the economy. Interest rates have been reduced by more than four per cent over the past ten years in response to weak growth and low inflation, with no significant progress being made by the European economy. Since then savers have to live with mini-interest rates since March 2016, the ECB interest rate is zero.

WHICH EFFECTS HAVE LOW INTERESTS?

Normally falling interest rates have a stimulating effect on economic growth. Failure to channel the extra money into productive and effective investment forced the central bank to take more action. Penalty rates for bank balances were introduced at banks' central bank accounts, and the ECB bought up state and corporate bonds and mortgage bonds on the capital market. The cheap money flowed into the stock and real estate markets, so that high demand in some countries exaggerated price developments that carry the seeds of new crises in themselves.

Low interest rates have a direct impact on the lives of borrowers and investors through the terms and conditions of commercial banks. Borrowers can borrow cheap and, for example, buy real estate that they would not have been able to afford years ago. Investors, on the other hand, have to take higher risks when investing in order to generate any appreciable proceeds. For retirement and target savings, more money needs to be raised to achieve the same results as years ago with higher interest rates.

WHAT STRATEGY PERSECUTES THE ECB?

The central bank wants to use monetary stimulus to bring inflation and economic growth in line. Another objective pursued by the ECB with its interest rate policy is the maintenance of price stability. It assumes that with an inflation rate of approximately two percent, demand for consumer goods and capital goods is highest and economic growth rates are promoted most effectively. As low-interest-rate policy has not reduced but increased the indebtedness of economic operators, their debt burden must remain bearable for as long as possible in order to avoid insolvency and favor debt reduction. This is especially true of the high level of European public debt, which is devouring more and more budgetary funds for debt repayment and interest payments. As long as the central bank's inflation target has not been reached, its interest rate policy will not normalize, so as not to jeopardize the recovery of the European economies through early interest rate hikes. Stable and economically strong states like Germany are earning money by issuing new government bonds because their real interest rates are negative. An undesirable consequence is that states are held back by necessary structural reforms due to the low lending rates. 

ENTWICKLUNG DER GEMITTELTEN LEITZINSEN DER EZB VON 1999 BIS 2016

Source: Statistisches Bundesamt; ECB (2017)

WHAT CURRENT PROGNOSES ARE THERE?

It is planned to continue the bond purchases of the European Central Bank by December 2017. At present, no end to the long period of low interest rates is foreseeable. Experts believe that interest rates will remain low for years to come, because politics and central banks want to prevent the rapid occurrence of another financial crisis at any cost. At present, there are first signs that cheap money from the ECB arrives in the real economy among businesses and private individuals through rising lending in the euro area. European growth rates are also growing outside Germany. Long-term interest rates are starting to rise tentatively as inflation expectations have increased over the next five to ten years. 

ARE THERE OTHER POSSIBILITIES OF SAVING? 

As an alternative to record-low interest rates, we can offer low-cost financial products such as Exchange-traded index funds, equities or digital forms of investment such as crowdlending and crowdinvesting for real estate. These financial assets are recommended because of their low cost, as they involve little or no acquisition costs that reduce the return on private investors. Equities and index funds show relatively large price fluctuations during their investment horizon, which do not occur in crowd lending and real estate crowdfunding. However, because the two investment alternatives involve greater risks due to their higher returns, a very broad spread of investment funds is important. Crowdinvesting for real estate is particularly suitable for risk diversification, as small investors are already able to participate in the real estate market with small amounts of € 500 or more and can map the real estate investment class in their portfolio. 

SUMMARY: 

- The aim of the low interest rate policy is economic growth and increasing the inflation rate to about two percent by increasing the money supply by increasing the volume of credit. 
- As the ECB target has not yet been reached, the low interest rate phase is likely to last for years.Nominal bank deposit rates are close to zero or negative. 
- Alternatives to saving and investing are low-cost investments such as equities, index funds, crowdlending, crowdinvesting for real estate. 
- Investors should keep an eye on risks and distribute capital on many individual investments. 
- Crowdinvesting for real estate offers investors this opportunity with a minimum investment of just € 500.