Posted on: 22nd January 2015 in FinanceEuribor (Euro Interbank Offered Rate) is a widely used benchmark for euro-denominated short term loans. Calculated and published every working day, it indicates the typical interest rate that European banks are asking for their lending on the interbank market for maturities ranging from 1 week to 1 year. Euribor effects on financial products Although Euribor and the interbank market only concern transactions where both parties (the lender and the borrower) are banks, changes in Euribor have significant effects on a wide range of financial products and their interest rates, such as floating rate bond yields, fixed income derivatives and also interest rates on consumer products like savings accounts, consumer loans and mortgages. Interest rates explicitly linked to Euribor Many financial products, especially in the corporate banking world, have their interest rates directly linked to Euribor. For example, when a company (such as a carmaker or an airline) issues variable interest rate bonds to finance their business, the bond’s prospectus (a lengthy document governing its terms and conditions) can contain a rule like this: The yield (interest rate) will be adjusted every 6 months (typically after a coupon payment) so that it is 80 basis points (0.80 percentage points) above 6-month Euribor. In practice, it means that when 6-month Euribor is 1.35% on the reset day, it will make the new yield equal to 2.15%, which will remain for 6 months until the next reset. As a result, both the issuing company and the investors who buy the bonds will closely watch Euribor, as it will directly affect their financing cost (for the company) or return on their investment (for the investors). How it works with consumer products Many consumer products like loans or mortgages work in the same way as the corporate bonds described above. For example, when you take a variable rate mortgage in euros, the interest rate can be expressed as 3-month Euribor + 1.20%. As a result, the interest on your mortgage goes hand in hand with Euribor and you are in the same position as the bond issuing company in the example above. If Euribor increases by 1 percentage point, so do the interest rate on your mortgage. This can be very dangerous in the current situation when Euribor is extremely low (all maturities below 0.30% at the time of writing this article). If it increases in the future, a variable rate mortgage that appears affordable now may become very expensive. Many consumer products have their interest rates not linked to Euribor explicitly, but they are still affected by its changes due to the nature of the banking business, particularly the fact that a bank uses the interbank market for short-term financing and effectively Euribor is a measure of its short-term financing cost. There are of course other factors (such as marketing and getting or retaining customers) which a bank takes into consideration when setting interest rates on savings accounts or loans, but in the long run it has to keep its rates in line with the overall interest rate level in the economy. For example, now with interest rates very low, it is hard to find a euro savings account earning more than 1-2%. In short, if you have financial products denominated in euros, it is worth knowing what Euribor is doing.
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