In recent years, low rates, even negative ones, have significantly boosted the economy in Europe. Particularly in the German real estate market, this led to a veritable boom. Private individuals and businesses were able to secure loans at favorable terms from banks to finance property purchases. Now, the talk is all about the increase in the key interest rate. What the key interest rate actually signifies, the potential implications of its increase, and its connection to real estate are all outlined in this article.

What is the key interest rate?

The key interest rate denotes the rate set by a central bank at which commercial banks can borrow or deposit money. There isn't just one key interest rate but three distinct ones. Of particular relevance to those interested in real estate is the main refinancing operation rate. This rate specifies the interest at which banks can borrow money over a longer period from the central bank (in the Eurozone, it's the European Central Bank - ECB).

Following years of low rates, the ECB raised the main refinancing operation rate by 0.75 percent to 1.25 percent in early September 2022 due to an inflation rate that reached record levels. A year later in September 2023, it has once again been increased by the same percentage points to a set rate of 2 percent.

Why is the key interest rate increasing?

Currently, we're in an inflationary phase, characterized by a long-term increase in prices of goods and services, meaning one gets less for their money. To counter this, the main refinancing operation rate is being raised. This rate serves as the primary financial instrument of the ECB as it indirectly influences interest rates in the money and capital markets, thereby controlling the refinancing costs of commercial banks. An increase in interest rates diminishes demand, leading to long-term price drops. Inflation is curbed by reducing the amount of money in circulation. The key interest rate is attributed a crucial role in the fight against currency devaluation due to its effects on the financial market.

What are the impacts of the increase in the key interest rate?

You might be wondering how the increase in the key interest rate affects everyone. It's quite straightforward. The higher the key interest rate, the more expensive it becomes for banks to borrow money from a central or reserve bank. Banks typically pass on the increased costs directly to consumers and businesses by raising the interest rates at which loans can be obtained. After all, banks don't want to bear the additional costs alone. With the increase in the main refinancing operation rate, costs rise not only for banks but for everyone. Such cost transmission aligns with the objectives of the ECB, as the increase in the key interest rate directly impacts the expenditures, loans, and savings of consumers within the currency area.

Sustained high demand for real estate

Presently, there continues to be substantial demand despite the rising interest rates. There are still more individuals looking to buy real estate than there are available properties on the market. This initially keeps prices high. However, we're approaching a phase where more real estate owners are reaching the end of their fixed interest rate period and will require a follow-up loan with significantly higher interest rates than before. This will prompt many owners to sell their properties. This situation presents opportunities. Due to the current market dynamics, not only will there be more properties available, but it will also offer better negotiation prospects for acquiring desired real estate, be it for personal residence or investment purposes.