Interest rate hikes are one of the most powerful tools central banks use to manage inflation and stabilize the economy. By making borrowing more expensive and saving more attractive, these policies are designed to slow consumer demand and ease upward pressure on prices. But while interest rate changes affect everyone, not all households react in the same way. A growing body of evidence shows that financial literacy—the ability to understand and apply financial concepts—plays a critical role in shaping how people adjust their behavior when rates rise.
This article explores how consumers respond to interest rate increases, drawing on insights from the European Central Bank’s (ECB) Consumer Expectation Survey (CES). It also highlights why financial knowledge determines whether households quickly adjust their saving and borrowing decisions or lag behind, potentially leaving them at a disadvantage.
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Why Interest Rates Matter for Consumers
Everyday financial decisions—whether to take a holiday, buy a home, or deposit money into a savings account—are deeply influenced by interest rates. Higher borrowing costs discourage loans for mortgages, cars, or personal expenses, while better returns on savings encourage people to delay consumption and set money aside.
When central banks like the ECB raise rates, their goal is clear: reduce spending and bring inflation under control. But consumer behavior depends not only on the direction of policy but also on how well individuals understand its implications. Financially literate consumers tend to recognize that higher rates signal more expensive borrowing and more rewarding saving. Those with limited financial knowledge, on the other hand, often struggle to connect policy shifts with personal decisions.
The Consumer Expectation Survey (CES)
To investigate these behavioral patterns, the ECB relies on the Consumer Expectation Survey, which collects responses from around 20,000 people each month across 11 euro area countries, including Germany, France, Spain, and Italy.
The survey tracks consumers’ experiences and expectations regarding:
- The economy – growth, employment, and inflation
- Financial markets – interest rates and borrowing conditions
- Personal outlooks – income stability and spending power
Importantly, the CES asks about the “optimal timing” of financial choices. Specifically, participants are asked:
- Is now a good time to borrow?
- Is now a good time to save?
To measure financial literacy, the survey uses a standardized set of questions developed by Lusardi and Mitchell (2011), covering:
- Compound interest
- Real versus nominal values
- Risk diversification
Respondents with high scores are classified as “financially literate,” while others are grouped as having “low financial literacy.” This distinction reveals stark differences in how quickly and effectively households adapt to policy changes.
The ECB’s Monetary Tightening Cycle (2022–2023)
The most significant monetary policy shift in recent years occurred between July 2022 and September 2023, when the ECB raised its key interest rate from -0.5% to 4.0%. This aggressive tightening was aimed at curbing soaring inflation across Europe.
Survey data show that consumers adjusted their expectations in line with policy moves:
- Expected mortgage rates rose from 3.3% in October 2021 to 5.5% in October 2023.
- Expected savings rates climbed from 1.6% to 3.1% over the same period.
By mid-2024, when the ECB began easing policy with its first rate cut, consumer expectations moderated slightly, reflecting a growing belief that borrowing would soon become cheaper and saving less rewarding.
How Consumers Reacted to Higher Rates
- The tightening cycle directly influenced perceptions of when to borrow and when to save.
- The share of consumers who believed it was a good time to borrow fell sharply—from 24% at the start of 2022 to just 12.7% in October 2023.
- Conversely, those who thought it was a good time to save rose from 26.9% to 40.9% over the same period.
This shift demonstrates how consumers adjust their financial timing in response to interest rate signals. Still, the speed and extent of these adjustments varied significantly depending on financial literacy.
The Role of Financial Literacy
While all consumers adjusted their expectations, financially literate households responded faster and more decisively.
Between July 2022 and September 2023:
- Highly literate consumers raised their mortgage and savings expectations by 1.2 and 0.8 percentage points, respectively.
- Less literate consumers increased their expectations by only 0.6 and 1.2 percentage points, respectively.
- The difference became even clearer in perceptions of timing.
- Financially literate households quickly concluded it was not a good time to borrow and shifted toward saving.
- Less literate households were slower to change their views, leaving them more exposed to rising borrowing costs and less able to capitalize on higher savings returns.
Charts from the CES reveal that expectations around mortgage and savings rates were the strongest drivers of consumer perceptions. However, the connection between rate expectations and actual decisions was much stronger among financially literate groups.
Why Financial Knowledge Matters
The survey findings underline a crucial point: financial literacy acts as a shield during periods of economic volatility.
Better decision-making
Households with strong financial knowledge can quickly assess whether borrowing or saving makes sense given current conditions. This helps them avoid costly mistakes, like taking on debt just before interest rates climb higher.
Stronger adaptability
Literate consumers are more flexible, adjusting strategies as policy shifts occur. They recognize opportunities—such as higher savings returns—more effectively than less literate households.
Improved resilience
By reacting in line with monetary policy, financially literate households are better positioned to maintain financial stability and protect long-term wealth.
Without financial literacy, consumers may misinterpret economic signals, delay necessary adjustments, or make choices that erode their financial security.
Broader Implications for Policy and Households
The CES results have two important implications:
For policymakers: Effective communication is vital. Central banks must ensure that policy messages reach all households, not just the financially literate. Simplified explanations of how rate changes affect borrowing and saving can reduce inequality in responses.
For households: Building financial literacy is essential. Understanding interest rates, inflation, and risk allows consumers to make informed choices, whether that means refinancing a loan, delaying a purchase, or boosting savings.
Educational initiatives—whether through schools, community programs, or workplace training—can play a major role in closing the gap.
Frequently Asked Questions:
What does financial literacy mean in the context of interest rate hikes?
Financial literacy refers to understanding key financial concepts such as interest rates, inflation, and risk. It enables people to make informed choices about borrowing and saving when central banks adjust rates.
How do interest rate hikes affect everyday consumers?
When rates rise, borrowing becomes more expensive, discouraging loans for mortgages, cars, or personal spending. At the same time, saving becomes more rewarding, encouraging people to delay consumption and deposit money.
Why do financially literate consumers respond faster to rate changes?
They can quickly interpret how rising interest rates increase borrowing costs and improve savings returns, allowing them to adjust decisions more effectively than less literate consumers.
What did the ECB Consumer Expectation Survey reveal about consumer behavior?
The survey showed that financially literate households significantly adjusted their borrowing and saving habits during the ECB’s 2022–2023 rate hikes, while less literate households responded more slowly.
How did perceptions of borrowing change during the tightening cycle?
The percentage of consumers who considered it a good time to borrow dropped from 24% at the start of 2022 to just 12.7% by late 2023.
How did saving attitudes change with higher interest rates?
As rates rose, more people viewed saving as attractive. The share of consumers considering it a good time to save increased from 26.9% to 40.9%.
Why is financial literacy important for households during inflationary periods?
It helps households avoid costly decisions, such as taking loans just before rates rise, and enables them to benefit from improved savings returns.
Conclusion
Financial literacy plays a vital role in shaping how households react to interest rate hikes. Consumers with stronger financial knowledge quickly recognize when borrowing becomes costly and saving becomes rewarding, allowing them to adapt effectively. Those with limited financial literacy often struggle to adjust, leaving them vulnerable to higher debt costs or missed savings opportunities. By improving financial education and making economic policies easier to understand, both individuals and policymakers can ensure households are better prepared to navigate future shifts in interest rates.
