Since the beginning of 2022, the Eurosystem has been tightening its monetary policy stance in response to the high levels of inflation. Key interest rates have already been raised eight times in succession since July 2022, and the main policy rate at which commercial banks can borrow money from the European Central Bank (ECB) currently stands at 4%. The aim of this monetary policy is to curb lending and to return the high inflation rate to the ECB’s 2% target through a reduction in aggregate demand. 

This has led to an increase in market interest rates and therefore also to changes in bank interest rates on loans and deposits in Germany. In the current Monthly Report, the Bundesbank’s experts examine whether the monetary policy measures are being transmitted, or “passed through”, on the scale they are supposed to. Is the pass-through of interest rates consistent or at odds with the relationships observed in the past between market interest rates and the various bank interest rates?

Stronger than expected rise in interest rates on loans for house purchase

It is normal for bank interest rates to respond to differing degrees and at differing speeds to changes in market interest rates which, in turn, are determined in part by monetary policy. However, an analysis by the Bundesbank has found that, since the beginning of 2022, banks in Germany have raised the interest rate on loans for house purchase more strongly than expected. This was probably due mainly to the significantly higher credit risk, which includes, for example, the risk that borrowers will fail to honour their payment obligations. For small-sized loans to enterprises, by contrast, the actual lending rate spent some periods during 2022 at levels that were below the interest rate that would have been normal based on past experience. This could be due to an increase in working capital loans to enterprises, the Bundesbank’s experts write. These loans typically have short interest rate fixation periods. Since the end of 2022, however, the interest rate on loans to enterprises has been moving in line with historical patterns again.

Rise in deposit rate only marginal

Unlike lending rates, the interest rate on overnight deposits has registered no more than a marginal rise so far. Although this phenomenon has also been evident in earlier periods of monetary policy tightening, the current pass-through of interest rates since the beginning of 2022 has been more sluggish than in the past, according to the Bundesbank experts’ latest assessment. Time deposits are a different story: interest rates on enterprises’ and households’ time deposits rose considerably and also significantly sooner than they did in the case of overnight deposits.

Effects on bank margins

The relatively rapid rise in lending rates and the stickiness of deposit rates meant that banks were able to widen their net interest margins in lending and deposit business. This could, however, be a temporary phenomenon. As competition for deposits picks up, the Bundesbank’s experts expect interest rates on overnight deposits to rise again. If interest expenditure then rises more strongly than banks’ interest income, margins could quickly contract again.

Expert conclusion for monetary policy

The increased interest rates brought about by the monetary policy tightening are dampening aggregate demand and, by extension, the excessively high inflation because, on the one hand, demand for loans is being slowed and, on the other, there is an incentive to save. The stronger pass-through of interest rates into loans for house purchase can probably be traced back to the higher risks in this sector. While the interest rate on time deposits has risen considerably and rapidly, that on overnight deposits has shown no more than a very modest increase by historical standards. However, it is to be expected that the growing competition for deposits – which are an important source of funding for banks – plus depositors shifting into time deposits could also lead to an imminent rise in deposit rates.