Decreasing ECB interest usually leads to lower mortgage rate

25/08/2009 15:00

From October 2008 to May 2009, the European Central Bank (ECB) reduced its main interest rate, the repo rate, step by step from 4.25 to 1.0 percent. It turns out that the level of this interest rate influences the level of mortgage interest rates in the Netherlands, especially rates for new short-term fixed rate mortgages.

Repo rate substantially down within a short space of time

The repo rate is an important tool to maintain price stability within the eurozone. One of the main guidelines for the ECB’s decision to change or refrain from changing its interest rate is the level of inflation in the eurozone. According to the ECB, prices in the eurozone are stable if the inflation rate is close to 2 percent. Inflation in the eurozone dropped quickly from mid-2008 to mid-2009: from 4.0 percent in July 2008 to -0.7 percent in July 2009.

Since 13 May 2009, the repo rate is at an unprecedented low level of 1.0 percent. In the seven preceding months, the ECB reduced the repo rate gradually from 4.25 percent to 1.0 percent. The ECB had never lowered the interest rate so substantially in such a short time.

These interest rate cutbacks can influence interest rates on the money and capital markets, including mortgage interest rates. The interest rate for newly negotiated mortgages in the Netherlands dropped from 5.6 percent in November 2008 to 4.7 percent in May 2009. In June, it increased slightly, to 4.8 percent. This is remarkable, considering the reduction of the repo rate in May.

1. Repo rate, mortgage interest rate and inflation

Repo rate, mortgage interest rate and inflation

Correlation between ECB repo rate and Dutch mortgage rate

There has been a significant correlation between the repo rate and the mortgage interest rate in the Netherlands in the period 1999-2009. The mortgage interest rate has a lag of approximately two months. This is caused by the time between the moment that a bank draws up its quote, and the moment the contract comes into effect. It is also possible that banks require some time to decide which interest rates they want to offer.

2. Correlation between repo rate and mortgage rate in the Netherlands

Correlation between repo rate and mortgage rate in the Netherlands

Particularly strong correlation between repo rate and short-term mortgage interest rate

Short-term fixed interest rates (with a fixed rate for up to one year) correlate particularly strongly with the repo rate. Interest rates of mortgages with a longer terms of fixed interest rates are influenced to a lesser degree by the level of the repo rate. The short-term mortgage interest rate dropped from 6.0 percent in October 2008 to 3.5 percent in April 2009. It subsequently rose slightly, to 3.8 percent in June. Interest rates of mortgages with longer fixed rate terms have hardly changed since April.

3. Repo rate and mortgage interest rates by term of fixed rate

Repo rate and mortgage interest rates by term of fixed rate

Wouter Jonkers