Do you feel that things are getting more expensive? What determines the cost of goods on the shelves, anyway? A huge factor behind the cost of living is interest rates. In the European Union (EU), these are determined by the European Central Bank (ECB).
In this article, our financial planners explain how the ECB affects the price level, what could happen to prices in 2025, and how British expats in the eurozone might be affected.
What is the ECB?
The ECB is the central bank of the eurozone. A central bank is not like your typical high street bank. Rather, it provides financial and banking services to your own bank, other banks, and the wider governing institutions.
Typically, a central bank is set up by a country. In the UK, for instance, the Bank of England (BoE) issues the UK currency (GBP) and oversees its monetary policy. However, the EU is unique in having a central bank which does this for twenty member states sharing the euro.
One of the key roles of the ECB (and other central banks) is setting the main interest rate. This is the lowest rate at which it lends to other banks. The latter set their own rates to customers somewhere above the base rate – e.g. when offering savings accounts and mortgages.
Why does the interest rate change?
Interest rates play a key role in determining how people behave in an economy.
If rates are high, people are more likely to save. This is because savings accounts start offering better rates, and mortgages get more expensive (leading to less disposable household income).
As such, rising interest rates can help to “cool down” an overheated economy. If inflation is rising too quickly due to high consumer spending, the central bank can raise interest rates to try and keep inflation within its target (for the ECB, this is 2%).
However, if central banks are not careful, high interest rates can stifle economic activity to the point where few people are spending money. This can lead to stalling growth or, in worse case scenarios, recessions (two consecutive quarters of falling GDP).
To counterbalance, a central bank might lower interest rates to encourage people to spend money. This might happen if GDP growth is weak and inflation is below the target.
However, the ECB always needs to watch the eurozone’s price level (inflation), its economy, and the wider macroeconomic context carefully, adjusting the base rate when it deems necessary.
The ECB: what’s going on right now?
In 2024, the ECB made headlines by making four cuts to the base rate. On 6 June, it was cut by 0.25 basis points to 4.25%. A steep cut was then made in September to 3.65%. It was lowered two more times in November and December.
This year, in January 2025, the base rate has been cut again – now standing at 2.90%. There are hints of further cuts to come later in the year. A primary driver behind these ECB cuts seems to be a desire to stimulate economic growth in the eurozone.
At present, the growth outlook is looking muted for the year ahead. By cutting the cost of borrowing, the ECB hopes to encourage more business activity and consumer spending.
The road ahead – how expats can plan
The eurozone is facing some challenges over the coming months. In particular, the threat of “Trump tariffs” from the US could have big repercussions.
For instance, a proposed 25% tariff on EU motor vehicle imports could hurt European car sales in the US (a huge market). Certain sectors in the European economy are likely to be affected more than others if America moves heavily towards protectionism.
Indeed, some analysts warn that Trump’s tariffs could even derail Europe’s growth plans for 2025. However, we will have to see how far Trump’s actions follow his rhetoric and how the EU responds to any import duties on its goods.
With this huge global variable at play, it does seem likely that further ECB cuts could arrive later in 2025. This is not a certainty, of course. However, the direction of travel suggests that savings accounts and mortgages denominated in euros could see their rates go down.
If this transpires, expats should be prepared by discussing their options with a financial adviser. Ideas include diversifying portfolios across currencies, not just markets and asset classes.
It is also good practice to check the health of your emergency fund, and to occasionally speak with your adviser about your investment strategy and asset allocation.
If you’d like to make sure you’re taking the right steps to safeguard your financial future, please get in touch.