Interest rates what they are and what effects they have

Interest rates: what they are and what
effects they have
You may have heard about interest rates, especially during the last
couple of years, since the pandemic started to hit the World. Interest
rates usually drive the financial world, but who set them and how they
affect the markets? Let’s have a look!
Interest rate is the remuneration that a lender receives and the cost
that a debtor incurs. A simple concept, which however often escapes
by chasing acronyms and index technicalities. Here are the most
important ones, to better orient yourself between mortgages and
economic policy.
The interest rate of the European Central Bank
The ECB rate is the general indicator of the entire Eurozone system
and that’s why it is called the “reference rate”. Once, when the rates
were national and the central banks of each economy decided them, it
was called the official discount rate but the substance does not
change: ECB rates are the main parameter for defining the main
refinancing operations.
In other words, they determine the cost of money which, passing
through the banks, affects the credit granted to households and
businesses. The ECB therefore has the role of regulator: if the
economy slows down, low rates stimulate investment, consumption
and – in general – greater circulation of liquidity; if the economy
accelerates, rates are adjusted upwards to prevent excessive
inflation.
Obviously, we’ve just taken ECB rates as an example, but the same
can be said about Federal Reserve, Bank of England, Bank of
Japan’s rates etc…
EURIBOR
EURIBOR stands for Euro Inter Bank Offered Rate. As the name
implies, it is the average interest rate of transactions between
European banks. In fact, banking institutions do not only lend money

to families and businesses but also exchange liquidity among
themselves.
Banks that have it in abundance make short-term loans to those that
are short of it. The EURIBOR, therefore, influences the cost of money
borne by the institutions, and represents the reference point for
variable rate mortgages, to which the bank adds a more or less high
spread.
EONIA
The EONIA is the Euro OverNight Index Average. In practice, it is
the overnight EURIBOR: the average interest rate at which banks
grant and request loans for a period of one day. That is, in the space
of one night (overnight, in fact).
LIBOR
LIBOR, or the London Interbank Offered Rate, is the UK equivalent
of EURIBOR. It is therefore the reference rate at which institutions
exchange money on the London interbank market. It is a floating rate,
calculated and published every morning by the British Banker’s
Association.
However, its impact does not end in the City: if the EURIBOR is the
reference rate for transactions in euros. LIBOR usually performs the
same function for exchanges in other currencies.
SONIA
From 1 January 2022, Libor switched to a system based on a set of
risk-free overnight rates with the acronym RFR. They are based on
transactions that took place the previous day. The new rates is
therefore decided on the basis of contracts already closed. Not on
estimates as was the case in the past.
What will they be? The Libor in British pounds will be replaced by
SONIA: an acronym for Sterling Overnight Index Average; the one
in euros will be replaced by the € STR (Euro Short-Term Rate); while
the SOFR, Secured Overnight Financing Rate, will come in place of
the libor in dollars. Substitutes for the Libor have also been found for
other currencies, such as: the Australian dollar; the Japanese yen and
the Swiss franc.

IRS (EURIRS)
If those who have taken out a variable rate mortgage must look mainly
at the EURIBOR, those who have chosen the fixed rate will have to
refer to the IRS (Interest Rate Swap), also called EURIRS. It is the
average rate at which the main European banks enter into swaps to
hedge the risk. It represents the basis (to which a spread will always
be added) for calculating interest on mortgages.
For more info visit Blink Trades.