ECB increases key interest rate to 2.5 percent: reasons and consequences

On December 15, 2022, the European Central Bank (ECB) increased the key interest rate again by 0.5 percentage points.

  • The main refinancing rate (top lending rate) will therefore be 2.5 percent from December 21.
  • The deposit rate, which largely determines savings rates for consumers, at 2 percent.

An important reason for the clear signal was the record inflation of 10.4 percent in October 2022, which remained at a high level of 10 percent in November. The ECB raised interest rates for the first time on July 21, marking the turnaround in interest rates.

The monetary watchdogs primarily want to bring down high inflation by lowering economic participants’ inflation expectations. It is also about the credibility of the ECB.

In the article, we first briefly describe in advance what is behind the interest rate hike and what consequences we can expect. We then explain what key interest rates actually are and, in more detail, how inflation and the ECB’s policy are related.

What is behind the rate hike?

The theory says: As long as (key) interest rates are low (as in the past few years), this encourages people to spend money. With consumption, the demand for goods increases and so prices rise. This can lead to inflation, so-called demand-induced inflation. Normally the central bank then raises (key) interest rates, saving becomes more attractive again, people consume less and prices go down.

However, the mechanism actually only works if inflation is demand-induced.

At the moment, however, prices are rising due to shortages of energy and other commodities. Inflation is said to be supply induced.

The central banks of the world are still raising interest rates because they want to prevent economic participants from seeing the high inflation rates as the new normal and pricing them in. The central banks have to react in order to maintain credibility and to be able to ensure stable prices that the economy and consumers can use to plan. This strategy may work in the medium term.

The short-term consequences of the interest rate hike

In the short term, however, higher (key) interest rates encourage people to save. Or we humans spend the money we have on expensive energy and can hardly consume anything else. So although we are de facto refraining from consumption, inflation is not falling for the time being. Scarce goods remain scarce (and expensive).

Consequences for the economy: Sluggish consumption and possible production losses can temporarily lead the economy into a recession. A recession occurs when a country’s economy shrinks for two quarters in a row. Then jobs may be lost, tax revenues collapse, etc.

Consequences for savers: There is again interest on deposit accounts and time deposit accounts. The vast majority of banks waive the custody fee for large sums of money in the current account. Loans, especially real estate loans, are becoming more expensive.

Some of the undesired economic consequences can possibly be curbed by government measures. Also read our articles on the relief package.

What is the prime rate?

The key interest rate is, so to speak, the interest rate of (credit) interest. It is the number one tool used by central banks worldwide to control the money supply and indirectly the level of consumer prices.

The so-called main refinancing facility is the actual key interest rate. There are also two other ECB interest rates, the top lending rate and the deposit rate. Sometimes all three interest rates are referred to as the key interest rate.

Main Refinancing Rate

It specifies the conditions on which banks can borrow money from the ECB over a longer period of time – between two weeks and three months. The central bank money is awarded to the banks via an auction process and ends up on their account at the central bank. The banks have to deposit collateral for this, usually in the form of bonds or mortgage bonds.

Ideally, banks then pass on the borrowed money to companies or private individuals with a surcharge in the form of loans, thus creating an incentive for consumption and investments. After years of zero interest rates, the ECB raised the key interest rate to 0.5 percent on July 27, further to 1.25 percent on September 14, to 2 percent on November 2 and to 2.5 percent on December 21.

Top Lending Rate

It is usually higher than the main refinancing rate, at 2.75 percent from December 21, 2022. Banks pay it when they need more money in the short term (overnight) to stay solvent. So it’s an urgent loan, so the rates the ECB is charging are higher. Alternatively, banks always have the option of getting money from other banks overnight (and ideally a little cheaper).

Deposit Rate

It is always below the main refinancing rate. It is the interest accrued when banks leave excess money in their central bank accounts overnight. Since 2020, the deposit rate has been minus 0.5 percent. The ECB only abolished this negative interest rate on July 21, 2022. Since then, banks have not had to pay penalty interest to the ECB if they (have to) park excess money with the central bank. Since September 14, the deposit rate was 1.25 percent, on November 2 it rose to 1.5 percent and on December 21 to 2 percent.

The savings interest for our checking account or call money account is derived from the deposit rate. Many banks had passed on the negative interest rate of the ECB directly, for example to customers who have more than 25,000 euros in their current account. Now that interest rates are turning positive, banks are largely eliminating negative deposit rates. More and more banks are responding with significantly better offers for fixed-term deposits or call money.

What are the effects of low and high interest rates?

The money supply can be influenced via the key interest rate, which in turn influences prices. But how exactly does a certain key interest rate affect consumers and companies?

That means a low interest rate

A low interest rate means that banks can access money cheaply. The supply of money increases in the short term. Every existing euro loses some of its value and this devaluation is noticeable through rising prices.

More precisely, the higher prices are due to the fact that consumers prefer to consume immediately rather than tolerate the devaluation of money in the savings account. When the demand for goods increases, prices rise.

At the same time, cheap lending rates and higher consumer demand encourage companies to invest in their production, for example to expand their business. A greater supply of goods would then cause prices to fall again somewhat.

Overall, there should ideally be a price increase of around 2 percent.

The central bank will lower interest rates or keep them low if it observes that prices are stagnating. The interest rate cut should then act as an impulse that allows consumers and companies to become active again.

That means a high interest rate

A high policy rate means that it is expensive for banks to access new central bank money. So they tend to do this less, and the supply of money decreases. Every existing euro thus gains in value. The same goods become cheaper.

More precisely, the lower prices are due to the fact that consumers prefer to postpone their consumption and instead save more because there is interest on the savings account – so saving is rewarded. If the demand for goods falls, prices fall.

At the same time, more expensive lending rates and lower consumer demand are slowing down corporate investment projects. It would be better to keep the existing business going. The same or lower supply of goods would cause prices to rise again somewhat.

The central bank will then raise the base rate or leave it at a higher level if it observes that prices are rising too much and the economy is “overheating”. The increase in interest rates should then act as a damper.

Who sets the prime rate?

The Governing Council, the supreme body of the central bank, consists of 25 members. The Council meets every two weeks and takes a look at the overall economic situation and makes forecasts on the economy and inflation. Based on this, it then makes a “monetary policy decision” every six weeks, i.e. sets the key interest rates.

ECB President Christine Lagarde then announced the decision in a press conference. This always takes place on a Thursday afternoon at 2.30 p.m. on the premises of the ECB in Frankfurt am Main.

Why is the base rate changing?

The ECB is aiming for “stable prices”. In practical terms, this means that the interest rate increases the money supply at best enough to increase consumer prices by 2 percent per year.

The ECB will always consider changing the key interest rate if it becomes apparent that the actual price development will deviate from this 2 percent over a longer period of time.

This is usually the case in certain economic phases: We usually see (too) low inflation in phases in which economic output is stagnating, the economy is “weakening” (such as during the corona pandemic in 2020 and 2021).

(Too) high inflation, on the other hand, can occur when the economy is “buzzing”. In this case, companies produce at the upper limit of their capacities. Consumers demand more than can be produced.

By controlling the money supply and price development via the key interest rate, the ECB can ideally also provide impetus for the economy – the overall economic situation. This benefits their downstream goal: to support “reasonable economic growth”.

Why is the ECB targeting 2 percent inflation?

This is primarily for psychological reasons. It’s about creating an incentive for consumers and businesses to consume and invest – and thereby keep the economy running.

The idea: as long as the central bank conveys the moderate depreciation of money credibly, consumers are more likely to spend money before it becomes less valuable in the savings account. Employees are more motivated because they can expect wage increases on paper. Companies can hope for higher prices when selling their products.

Because of the devaluation of money, workers can practically no longer really afford it, companies do not make any higher profits in real terms. Nominally, however, higher sums are on paper. But that is enough for economic participants to become active and for an economy not to stagnate.

This is how the key interest rate has developed over time

In the years following the financial crisis, the ECB and the Fed continued to lower interest rates, most recently to zero. In addition, the central banks bought government bonds. The ECB also bought government bonds from highly indebted EU countries – and thus gave them (cheap) credit.

The central banks put a lot of cheap money into the market with the aim of keeping the economy running – and, in the case of the ECB, keeping the euro zone together. At the height of the sovereign debt crisis in 2012, then ECB boss Mario Draghi announced that he would “do everything to save the euro.”

In view of record inflation of at least 10 percent in the euro zone and also 10 percent in Germany since September 2022, the pressure on central banks to stop currency depreciation and get inflation expectations under control increased. The key interest rate plays a decisive role in this. The targeted inflation is actually 2 percent.

On June 15, the Fed surprisingly raised the key interest rate by 0.75 percent to a corridor of 1.5 to 1.75 percent, increased it further at the end of July to a corridor of 2.25 – 2.5 percent and finally up in October 3.75 – 4 percent. The ECB increased the key interest rate by 0.5 percentage points on July 21, 2022. On September 14 and November 2, they rose by a further 0.75 percentage points. The main refinancing rate (top lending rate) will be 2.5 percent from December 21.

The dangers of interest rate developments

The challenge for the central bank is to always adjust the key interest rate in such a way that consumer prices rise by 2 percent over the long term. However, this is easier in theory than in practice.

Above all, because inflation does not always result from a higher demand for goods, but sometimes also from a shortage of supply.

And so the interest rate policy of the ECB is also reaching its limits and a certain interest rate development also entails problems. We have compiled the most important ones for you.

When zero interest rates no longer have an effect

There are situations – such as the sovereign debt crisis in 2012 or the outbreak of the corona pandemic in 2020 – in which prices do not rise even though there is a lot of cheap money available. The reason is that both consumers and companies are skeptical about the overall economic situation and are acting rather cautiously.

When a rate hike has no effect

Conversely, there are also situations in which an interest rate hike is unlikely to do much good. Namely when prices rise because of a tight supply and not because of the money supply. Interest rate policy is reaching its limits.

After the first corona shock, for example, companies started up production again in 2021. This not only caused the demand and prices for energy to rise. Many imported components of goods or raw materials were now scarce and therefore significantly more expensive.

When gas and oil became even scarcer and more expensive after the start of the Russian war of aggression in Ukraine, and this had an impact on electricity and petrol prices, inflation in Germany climbed to 10 percent in September 2022

Wage-price spiral

If (high) inflation lasts too long and the cost of living rises significantly, sooner or later employees will demand more wages from their employers – as inflation compensation.

In the worst case, a so-called wage-price spiral results. In that case, companies would pass on the higher labor costs to prices – which further fuels inflation.

A central bank would have to intervene decisively here and raise key interest rates in order to suppress inflation. However, if the economy is not strong enough, there is a risk of a recession.

How interest rates affect savers

While borrowers benefit from low interest rates, it is the opposite for savers. Low (negative) deposit interest rates mean zero or penalty interest on the checking account or call money account.

With the “interest rate turnaround” in July and September, interest rates on savings also rose again. If you invest your money in a Swedish bank for 12 months, you will at best be credited with a good 2.76 percent interest per year (as of December 16, 2022). Find out more in the fixed deposit comparison.

Banks should also now be able to abolish penalty interest for high balances across the board. The deposit rate, which banks have to pay for too much cash at the ECB, will be 2 percent from December 21. Previously it was minus 0.5 percent, zero percent, 0.75 percent and most recently 1.5 percent in November.

So you can use the interest rate development for yourself

At the moment we are observing the first positive interest rates on savings, exploding interest rates on loans and inflation of 10 percent due to the scarce supply of raw materials and energy. We’ve collected a few tips on how to best use this for yourself.


Think carefully if you buy a property now. Lending rates have already tripled since the beginning of the year. Buying is most likely worthwhile if you are sure that you will use it yourself and can raise a considerable part of the purchase price with your own capital. Financing inhabited real estate as a capital investment is becoming more and more expensive and can hardly be offset by the low existing rents. So you’re probably paying for it.


Because of the low interest on savings, the motto has long been to invest money in so-called tangible assets instead of leaving it in the account. This includes real estate, but also stocks. Now, however, real estate prices continue to rise (with interest rates rising) and global economic data are also rather meager, which can weigh on the stock market.

On the other hand, interest rates on savings are slowly but surely returning. There is already an interest rate of 1.45 percent on Swedish fixed-term deposits with a term of 12 months. Negative interest rates on checking accounts have almost disappeared. This is far from offsetting inflation, but it is a first step.

A pragmatic solution: diversify your investments. Do some long-term investing in international stocks (via ETFs ), keep some money upside down. If you are concerned with maintaining value, you can also invest up to 10 percent of your assets in gold – although the precious metal is also more expensive than ever. Consider leaving money that you can spare for a year or two at a bank that offers slightly higher interest rates. Take a look at our fixed deposit comparison here.


We advise against investing in speculative and highly volatile products such as cryptocurrencies. The fact that some traditional investments are no longer quite as attractive does not mean that you can suddenly make easy profits with Bitcoin and Co. On the contrary, recently crypto values have lost immensely in value. One also speaks of the crypto winter. So you can lose a lot. Therefore, invest at most money in cryptocurrencies and Co. that you do not need (“play money”).

Save Energy

Reduce your consumption of electricity, gas and petrol as far as possible, for example with your own (possibly subsidized) solar system on the roof or balcony or by driving slowly on the motorway. Wherever they exist, take state subsidies with you (KfW loans for building a house, energy money, etc.).

What is the current interest rate forecast?

Earlier than expected, the Governing Council of the ECB decided to phase out the purchase of government bonds. Instead of in the third quarter, as was previously known, the purchase program was stopped on July 1st. In a blog post from May 23, 2022, ECB boss Lagarde made a surprisingly clear case for a normalization of monetary policy. The rate hikes announced by the ECB on July 21 were even higher than the previous announcement. The significant rate hikes on September 14 and November 2 underscore that the ECB is serious about fighting inflation and even accepts a recession to do so.

The hike in interest rates should have less of an impact on current inflation, triggered by scarce energy sources. However, the ECB bases its forecasts more on so-called core inflation, which does not reflect temporary increases in energy and food prices, but rather reflects the economy’s inflation expectations.

These are now more than 4 percent and are therefore too high. An ultra-loose monetary policy that has to combat dis-inflationary tendencies (i.e. downward price pressure) is no longer necessary. Instead, a rapid normalization of monetary policy is appropriate.

For the euro zone, the ECB had already adjusted its inflation forecast significantly upwards to 8.1 percent for 2022 as a whole, from 5.5 percent for 2023 and from 2.3 percent for 2024.

At the press conference on December 15, the central bank once again presented updated figures. Accordingly, inflation will be 8.4 percent in 2022, 6.3 percent in 2023, 3.4 percent in 2024 and 2.3 percent in 2025.

Current ECB interest rates

On December 21, 2022, the ECB’s main refinancing rate (“the policy rate”) for medium-term loans will rise from 2 percent to 2.5 percent, the top lending rate for short-term loans from 2.25 to 2.75 percent and the deposit rate from 1.5 percent 2 percent.

You can take that from the text

Central banks such as the European Central Bank (ECB) and the American Federal Reserve (Fed) use the base rate as an instrument to control the money supply on the market and thus indirectly consumer prices.

The base rate is the top lending rate and defines how expensive it is for banks to ask for central bank money.

The higher the interest rate, the more expensive it is for banks to borrow money. Demand falls, money becomes tighter, prices rise. Conversely, a low interest rate often means higher demand for money, more money in circulation and prices falling.

The aim of the ECB is to set the key interest rate in such a way that there is inflation of 2 percent in the medium term. This gives consumers and producers the impetus to take money in their hands – that is, to consume or produce – before it becomes less valuable in savings accounts. That keeps the economy going.

There are situations in which interest rate policy reaches its limits. For example, when the key interest rate is already at zero, i.e. there is free central bank money, but there is no demand for it. This can be the case in times of economic uncertainty, such as during the sovereign debt crisis of 2012 to 2015 or after the outbreak of the corona pandemic in 2020.

On the other hand, there are circumstances that might make an interest rate policy ineffective. For example, when the price increases are triggered by a scarce supply of energy sources, as is the case at the moment. However, the inflation expectations of the economy and the development of the so-called core inflation, which do not take price shocks in energy and food into account, are decisive for the ECB.

In May 2022, ECB President Lagarde advocated a normalization of monetary policy, as inflation expectations in the euro zone were now clearly positive. An ultra-loose monetary policy intended to combat disinflationary tendencies (downward price pressure in a sluggish economy) is no longer appropriate.

On July 21, 2022, the ECB announced that it would raise the main refinancing rate from zero to 0.5 percent. The top lending rate rose to 0.75 percent. The deposit rate is no longer negative but has been raised to zero percent. On September 14 and November 2, all interest rates rose again by 0.75 percentage points; by a further 0.5 percentage points as of December 21.

Mortgage interest rates are picking up again. But interest rates on savings are also slowly rising. As a consumer, it is best to diversify your investment. Invest a part in international equity funds (ETFs), maybe mix in some gold, only buy a property if you plan to move in yourself and bring a decent amount of equity with you. Leave a buffer in the checking account.

Frequently asked questions about the key interest rate (FAQ)

How does the prime rate work?

The interest rate affects the money supply in the market and this affects consumer prices, according to economic theory.

To put it very simply: if the key interest rate is low and there is more money available on the market, every single euro is worth less. Goods prices rise and inflation rises.

Conversely: If you set the key interest rate high, you take money from the market, every single euro is worth more. Prices go down, inflation goes down.

In an equilibrium with stable prices and stable economic output, the key interest rate would be set in such a way that banks demand a certain amount of money and pass this on to the economy as loans (money supply corresponds to money demand).

Companies and private individuals invest accordingly. Part of the money is consumed. The rest ends up in savings accounts (savings rate equals investment rate).

What does a higher interest rate mean for homebuyers?

The interest rate hike also triggered interest rates on real estate loans to rise.

It is particularly hard for anyone who currently wants to buy a house or apartment. On the one hand, real estate prices continue to rise – not least because of the shortage of building materials – and financing is also becoming more expensive. Within a few months, interest rates for residential construction with a 10-year fixed interest rate have tripled.

For many, the dream of owning their own home is likely to be a thing of the past again.