Euro short term rate

What Is Euro Short-Term Rate (€STR)?

The Euro short-term rate (€STR) is a key overnight interest rate benchmark for the euro area, reflecting the wholesale euro unsecured overnight borrowing costs of banks. As a crucial element within financial benchmarks and the broader money market segment, €STR provides a consistent reference point for short-term borrowing across euro-denominated financial markets. It is administered and published daily by the European Central Bank (ECB). Unlik⁶⁴e previous benchmarks, €STR includes a broader set of financial counterparties beyond just interbank lending, making it a more representative measure of the cost of unsecured overnight funding for euro area banks.

His⁶³tory and Origin

The genesis of the Euro short-term rate (€STR) stems from a global initiative to reform financial benchmarks following concerns about the integrity and robustness of existing rates, notably LIBOR. On September 20, 2017, the ECB's Governing Council made the decision to develop a new euro overnight rate, leveraging data already collected by the Eurosystem for money market statistical purposes., This new ⁶²rate was designed to complement private sector benchmarks and serve as a fallback.

A workin⁶¹g group on euro risk-free rates, established by European authorities, played a pivotal role in recommending €STR as the preferred replacement for the Euro Overnight Index Average (EONIA)., The ECB of⁶⁰f⁵⁹icially began publishing the €STR on October 2, 2019, reflecting trading activity from the previous day., This marked ⁵⁸a⁵⁷ significant moment in the European financial landscape, as €STR was intended to eventually succeed EONIA. A carefully pla⁵⁶nned transition period followed, during which EONIA’s methodology was modified to be calculated as €STR plus a fixed spread., EONIA was ultimate⁵⁵l⁵⁴y discontinued on January 3, 2022, with €STR becoming the sole overnight benchmark rate for the euro.

Key Takeaways

• ⁵³ The Euro short-term rate (€STR) measures the wholesale unsecured borrowing costs of euro area banks in the overnight market.
• It is calculated and published by the European Central Bank (ECB) every TARGET2 business day.
• €STR is considered a "near risk-free rate" because it primarily reflects actual transaction data and aims to exclude material bank credit risk.,
• It successfully repl⁵²a⁵¹ced the Euro Overnight Index Average (EONIA) as the primary overnight benchmark for the euro area in January 2022.
• The rate is calculate⁵⁰d as a volume-weighted trimmed mean, which enhances its robustness by removing outlier transactions.

Formula and Calculati⁴⁹on

The Euro short-term rate (€STR) is calculated as a volume-weighted trimmed mean of eligible overnight rate transactions. This methodology ensures the rate is robust and less susceptible to distortions from extreme values or errors. The calculation process involves:

1. Ordering Transactions: All eligible unsecured overnight fixed-rate deposit transactions exceeding €1 million, conducted by euro area banks with financial counterparties, are ordered from the lowest interest rate to the highest.,
2. Aggregating Transactio⁴⁸n⁴⁷s: Transactions occurring at each rate level are aggregated by volume.
3. Trimming: The top and⁴⁶ bottom 25% of the total volume of these transactions are removed. This "trimming" process helps to protect the rate from idiosyncratic volatility caused by transactions priced off-market or data errors.,
4. Calculating the Mean⁴⁵:⁴⁴ The €STR is then calculated as the volume-weighted average of the remaining 50% of the transaction volume. A pro-rata calculation is applied at the thresholds to ensure exactly 50% of the total eligible volume is used.,

The formula can be conceptual⁴³i⁴²zed as:

Where:

• (Rate_i) represents the rate of an individual eligible transaction.
• (Volume_i) represents the volume of that individual eligible transaction.
• (N) is the total number of eligible transactions remaining after trimming.

The €STR is rounded to the third decimal place. This robust calculation process, ba⁴¹sed on the Money Market Statistical Reporting (MMSR) data, ensures its reliability.

Interpreting the Euro Short-Ter⁴⁰m Rate

The Euro short-term rate (€STR) serves as a critical indicator of the cost of borrowing for euro area banks on an unsecured, overnight basis. Its interpretation is straightforward: a higher €STR indicates that banks are paying more to borrow euros overnight, while a lower €STR suggests reduced borrowing costs.

Since €STR is designed to be a "near risk-free rate," it largely reflects underlying liquidity conditions in the euro area money market, with minimal influence from bank-specific credit risk. Market participants use €STR to gauge the g³⁹eneral level of short-term interest rates and as a reference for pricing various financial instruments. Because it is an overnight rate published in arrears, the precise interest payable for periods longer than overnight is determined at the end of the interest period, often requiring compounding conventions.

Hypothetical Example

Imagine "Eurobank A³⁸lpha" needs to borrow €100 million for one night to cover a temporary liquidity shortfall. "Eurobank Beta" has a surplus of funds and is willing to lend. These are both euro area banks engaging in an unsecured borrowing transaction.

On a given day, after aggregating all eligible transactions over €1 million reported under the Money Market Statistical Reporting (MMSR) framework, the ECB calculates the €STR. Let's say, after trimming the top and bottom 25% of the transaction volumes, the weighted average of the remaining transactions is 3.500%. This 3.500% would be the published €STR for that day.

If Eurobank Alpha and Eurobank Beta agree to a loan at the €STR rate for €100 million overnight, Eurobank Alpha would pay Eurobank Beta the following interest:

Interest Payment = Notional Amount × (€STR / 360)
Interest Payment = €100,000,000 × (0.03500 / 360)
Interest Payment = €9,722.22

This small, overnight transaction demonstrates how the €STR directly reflects the actual borrowing costs banks face in the wholesale market, influencing their day-to-day liquidity management.

Practical Applications

The Euro short-term rate (€STR) has become integral to the euro area's financial markets, serving as a foundational interest rate for a wide array of transactions and analyses.

• Derivatives and Hedging: €STR is widely used as the reference rate in euro-denominated derivatives contracts, particularly Overnight Index Swaps (OIS). These instruments allow financial institutions to manage their exposure³⁷ to fluctuations in overnight borrowing costs.
• Floating Rate Loans and Bonds: Financial institutions increasingly use €STR to price floating-rate loans and bonds. This provides transparency and links the interest payments directly to the actual unsecured overnight borrowing costs of banks.
• Collateral and Discounting: Central banks and clearing houses have shifted to using €STR for discounting future cash flows and valuing collateral in various financial operations.
• Monetary Policy Operations: The ECB utilizes €STR as a key indicato³⁵r to assess conditions in the euro area money market and to guide its monetary policy decisions.
• Benchmark for Fallback Rates: For financial contracts that still refe³⁴rence the Euro Interbank Offered Rate (EURIBOR), €STR is often recommended as the primary basis for a fallback rate, in case EURIBOR is discontinued or its methodology changes significantly., This ensures continuity and stability in contracts. The new benchmark rates, i³³n³²cluding €STR, addressed major challenges for the financial sector by providing new reference rates.

Limitations and Criticisms

Despite its robust methodology and widespread ado³¹ption, the Euro short-term rate (€STR) has certain characteristics that present limitations or challenges in its application.

One primary aspect is that €STR is an overnight rate published "in arrears." This means that for financial products with interest periods longer than one day (e.g., monthly or quarterly), the exact amount of interest payable is not known until the end of the agreed interest period, as it requires compounding the daily €STR rates. This "look-back" or "lag" convention can introduce operational complexities for market ³⁰participants, who are accustomed to term rates like EURIBOR where the interest rate for the period is known at the start.

Another point of discussion concerns the scope of transactions included. While €STR ex²⁹panded beyond the narrow interbank lending of EONIA to include transactions with a wider range of financial counterparties, it specifically excludes secured borrowing transactions., Some argue that a more comprehensive rate might also incorporate secured segments of the^{28 27}market to provide an even broader view of funding costs. The shift from older benchmarks like EONIA and LIBOR to new risk-free rates such as €STR also presented considerable challenges for market participants to migrate all products and contracts within deadlines.,

Euro Short-Term Rate vs. Euro Overnight Index Average

The Euro short-term rate (€STR)^{26 25}and the Euro Overnight Index Average (EONIA) were both overnight interest rate benchmarks for the euro. However, significant differences in their calculation and underlying market representation led to €STR replacing EONIA as the preferred benchmark.

The transition from EONIA to €STR was part of a global effort to move away from benchmarks base¹⁴d¹³ on expert judgment or limited transactions, toward rates grounded in a broader set of actual, verifiable transactions. This move enhanced the reliability and representativeness of the euro's key overnight rate.

FAQs

Who publishes the Euro short-term rate (€STR)?

The Euro short-term rate (€STR) is calc¹²ulated and published daily by the European Central Bank (ECB).

Why was €STR introduced?

€STR was introduced as part of a global reform of financial benchmarks to enhance the robustness and reliability of reference rates. It replaced the Euro Overnight Index Average (EONIA) due to EONIA's reliance on a smaller pool of transactions and its inclusion of a bank credit risk component. €STR is based on a wider set of actual, unsecured overnight transactions, making it a more representative and near risk-free rate.,

How often is €STR published?

€STR is published every TARGET2 business day at 8:00 Central European Time ¹⁰(⁹CET). The rate reflects transactions conducted and settled on the previous TARGET2 business day., TARGET2 is the real-time gross settlement (RTGS) system owned and operated by the Eurosystem.

Does €STR direc⁸t⁷ly affect consumer lending rates?

While €STR is a fundamental interest rate in the euro area, it does not directly impact consumer lending rates for credit cards, personal loans, or mortgages. These retail rates are typically influenced by longer-term benchmarks like EURIBOR (Euro Interbank Offered Rate) and a bank's own funding costs, credit assessments, and commercial strategies. However, as a foundational rate, broad movements in €STR can indirectly influence the wider financial market conditions⁵ that eventually affect consumer rates.

What is the difference between €STR and EURIBOR?

Both €STR and EURIBOR are euro interest rate benchmarks, but they measure different things. €STR is an overnight rate reflecting the unsecured borrowing costs of banks in the euro area for one day. EURIBOR (Euro Interbank Offered Rate), on the other hand, is a forward-looking term rate reflecting the average rate at which a⁴ panel of banks would lend to one another in the unsecured euro interbank lending market for various maturities (e.g., one week, one month, three months). While €STR is a near risk-free rate, EURIBOR includes a bank credit risk com³ponent and a term premium.,¹²