“Neutral” interest rates in Europe: Why do they matter?

“Neutral” interest rates in Europe: Why do they matter?

In an uncertain economic environment characterized by heightened interest-rate volatility, thinking in terms of neutral interest rates helps identify a key benchmark to better understand today’s financial dynamics. Let’s explore their role and impact.

The “neutral” interest rate: a key economic equilibrium

The neutral interest rate is a fundamental concept in economics and finance. It corresponds to the level of interest rates that neither stimulates nor constrains economic activity. In other words, it balances the supply and demand for capital without generating excessive inflation or slowing economic growth.

How is it estimated?

This rate is not directly observable but estimated based on several factors:

• Potential economic growth

• Central banks’ inflation targets

• Productivity levels and available savings

How does it relate to Euribor?

Euribor, the main benchmark rate of the European interbank market, closely follows ECB monetary policy decisions and its policy rates. The ECB currently estimates the neutral rate to lie between 1.75% and 2.25%.

If Euribor is above this range, borrowing becomes more expensive and may weigh on economic activity. If it is below, it supports investment and consumption, albeit with a risk of excessive inflation.

Where do we stand today?

The 3-month Euribor is close to 2.40%, suggesting that monetary policy remains slightly restrictive and leaving room for potential policy-rate cuts later this year.

However, forward Euribor rates (the market’s expectations of future Euribor levels), which are highly volatile, have recently risen to 2.50%–3.00% over 3- to 5-year maturities (+30 to +50 basis points across maturities over the past three weeks). These levels reflect the expected future cost of money in light of major anticipated investments (defense spending, infrastructure, and the energy transition).

Upcoming geopolitical developments over the coming months will inevitably influence these expectations, and therefore the cost of (re)financing and interest-rate hedging.

Conclusion: In uncertain markets, the neutral interest rate and Euribor projections provide essential reference points when thinking about your financing cost budgets and upcoming (re)financing decisions.