The European Central Bank (ECB) increased interest rates by more than expected on Thursday, raising its benchmark deposit rate by 50 basis points to zero percent, impacting the Cyprus banking system and local borrowers.
The ECB moved to join its global peers in jacking up borrowing costs, ending an 11-year policy of historically low-interest rates.
The ECB’s decision also ended an eight-year experiment with negative interest rates while increasing its main refinancing rate to 0.50%.
It promised further rate hikes, possibly as soon as its next meeting on 8 September.
Leading up to Thursday’s decision, the ECB had warned markets to expect a 25-basis point increase, but indicators pointing to a further deterioration of the inflation outlook pushed the authority into having second thoughts.
With inflation already approaching double-digit territory, it is at risk of getting entrenched above the ECB’s 2% target.
Any gas shortage over the coming winter will likely push prices even higher, perpetuating rapid price growth.
What this means for Cyprus
In practice, this means that borrowers who have taken out loans with a floating interest rate based on the Euribor will be repriced with instalments increasing accordingly.
The change in monetary policy will also affect the loans in the portfolios of the credit acquisition companies, intensifying the pressure on borrowers who have difficulty meeting their loan obligations.
Borrowers who choose to take out loans with a locked interest rate will not be affected.
On the other hand, Cyprus’ banking sector is expected to benefit, as banks no longer hold their deposit excess with the ECB at a negative rate.
The Central Bank said in its latest report on the banking system’s stability, “as net interest income is its dominant source of income, it is expected to have a positive impact on its profitability”.