What the interest rate cut means and implies

Brussels – Down with interest rates. The choices made by the European Central Bank affect the real economy. How? By making it cheaper to borrow money. The cost of capital becomes cheaper, which stimulates demand. Let’s take a closer look at what it means.

What does an interest rate cut mean

Reducing interest rates is nothing more than a decision to lower the cost at which central banks lend money to banks. Having more money becomes cheaper, and this affordability is passed on to customers, including citizens and entrepreneurs, when loans are applied for. It essentially becomes cheaper and therefore more attractive to take out mortgages and make investments.

Shares and bonds

Speaking of investments, a reduction in interest rates affects the choices of those who want to invest some of their savings. Better stocks or bonds? In this case, the choice to reduce borrowing costs moves money. Stocks become more attractive than bonds, with savers more likely to invest in the stock market. This is because bonds are seeing their yields reduced, unlike equities, which can yield higher profits.

The rate cut for public debt

A reduction in interest rates also benefits governments, which pay lower interest on the yield of their sovereign debt securities. For countries like Italy, with a high level of public debt relative to gross domestic product, lower rates ease the burden of repaying bearer bonds.

Implications for banks

Banks can earn less money by lending at a lower interest rate, which means lower revenue. However, in the case of existing mortgages and new loans, this means exposing oneself less to the risk of insolvency on the part of households and companies and reducing the phenomenon known as impaired loans (loans that are difficult to recover). It may happen that some lending institutions increase operating costs and fees to recover some of the lost revenue resulting from the decrease in borrowing costs, consequent to the reduction in interest rates.