Bright spots in EU bank bonds as rates rise

THIS month, the European Central Bank (ECB) decided to raise its key interest rates by 75 basis points (bps). The interest rate on the main refinancing operations will be raised to 1.25 per cent. Since 2016, the interest rate on the main refinancing operations has remained at zero, up until July 2022 where the ECB announced its first interest rate hike after 6 years. The central bank has turned hawkish in its remarks on combating inflation, and so far increased its key interest rates twice in 2022.

According to Eurostat’s flash estimate, inflation is expected to come in at 9.1 per cent in August. Inflation remains elevated in the eurozone due to soaring food and energy prices and supply bottlenecks. Looking ahead, the ECB have revised their inflation projections upwards to 8.1 per cent in 2022; 5.5 per cent in 2023; and 2.3 per cent in 2024. With inflation and interest rates expected to remain elevated, we think European Union (EU) banks are set to benefit.

When interest rates rise, so does the spread between long-term and short-term rates. This helps banks, since they borrow on a short-term basis and lend on a long-term basis. Interest rate hikes help to boost their net interest margins and subsequently improve net interest income.