Fixed rate interest rates set by the ECB 2008-2023
How does this ensure liquidity?
Banks only hold a fraction of their capital in cash on hand. This amount, often measured by the Tier 1 capital ratio, is generally low because the banks would rather use their capital to issue revenue-generating loans. When the capital on hand gets too low, commercial banks go to the ECB for a short-term loan. In contrast, commercial banks can also deposit funds with the ECB for a lower interest rate.
Reasons for fluctuations
The ECB’s mandate is to ensure price stability. This means that, in theory, the only indicator that should matter to the ECB is the Euro area inflation rate. When the fixed interest rate in this statistic is lower, commercial banks ask for more loans from the ECB. This increases the money supply, which in turn raises inflation. When inflation is higher, the ECB will raise this rate, reversing the effect.