Europe’s central banks continue to battle stubborn inflation, hinting at more rate cuts amid ongoing uncertainty over the region’s interest rate trajectory.

Against this backdrop, investors need a quick and reliable way to hedge their risk. Growing divergence between central banks was illustrated at the start of 2024 when the U.S. Fed indicated that they expected to cut rates by ~75 basis points this year while the European Central Bank and Bank of England cautioned against complacency on consumer price pressures. In fact, both the ECB and BoE have since cut rates for the first time in many years while the U.S. Fed has yet to make its first move.

August saw this year’s biggest daily volumes in Euribor futures with two consecutive days of 3 million+ contracts traded. Euribor options traded 790,000 on August 2; the total volume in the Euribor complex that day was over 4 million.

As a key bank-to-bank lending rate, the Euribor benchmark is used across trillions of dollars of financial instruments in the global system. It has provided reliable liquidity throughout periods of market uncertainty, including times characterized by low market activity - like the COVID-19 pandemic - or high volatility, such as rapid tightening in Europe’s monetary policy.

In December 2023, the European Securities and Markets Authority (ESMA) Euro Risk-Free Rates Working Group announced that European Union interest rate reform was complete. The group noted Euribor’s “systemic importance” in the EU, and that the benchmark is here to stay. “In the bond and loan markets, the predominant benchmark remains EURIBOR, reflecting both the continued availability of EURIBOR and preferences of the majority of market participants” the group said.

The methodology which underpins Euribor continues to be strengthened. As Euribor’s administrator, the European Money Markets Institute (EMMI) recently completed a consultation that aims to diversify its panel of banks to provide a broader picture of euro-denominated lending costs. In addition, EMMI aims to reduce the burden on firms which already contribute to Euribor’s calculation by using a standardised approach. Proposed changes could take effect this year.

Euribor operates in parallel with the latest risk-free overnight rate, €STR (euro short-term rate) which reflects the actual overnight borrowing costs of banks within the eurozone. Both interest rate benchmarks serve a purpose, and the market continues to support Euribor futures and options contracts.

Familiarity, simplicity and flexibility

Familiarity is a key reason why Euribor endures as an interest rate benchmark. Euribor contracts are well understood by market participants, which carries weight in an uncertain economic environment. This understanding leads to support, creating a transparent and fair market that aims to retain investor confidence.

Simplicity is another factor. Euribor term rates out to 12 months make it easier for corporates to hedge their interest rate risk compared to the more complex calculations that accompany a risk-free overnight rate. It allows them to focus on their core business, rather than concerning themselves with the nuances of various financial markets.

There is also an element of flexibility to the Euribor benchmark. It has a built-in credit component because it represents an uncollateralized cost of borrowing by a bank. Many market participants believe that a short-term rate with an inbuilt credit component better serves the needs of lenders and borrowers. Amid a backdrop of higher interest rates, this component becomes even more important for price discovery of risk.

Therefore, Euribor provides trading opportunities for market participants, allowing them to take leveraged positions in a more cost-efficient way. The result is greater liquidity across the entire market, reducing costs for all participants.

A strong, diverse participant mix

The sheer diversity of participants in ICE’s Euribor’s derivative markets underpin its strength. It’s a mix which includes banks, asset managers, algorithmic traders, hedge funds, proprietary traders and other market participants which need to manage their risk. Across financial markets, the ability to quickly enter or exit a position is crucial in periods of instability, and the depth of Euribor’s liquidity provides assurance to market participants.

EMMI chief executive Jean-Louis Schirmann says, “Published since 1999 in parallel with the introduction of the euro, Euribor has withstood various global crises and proven its robustness. EMMI is currently implementing a modification in its waterfall methodology in which Level 3 would be eliminated, thereby reinforcing the model-based and formulaic approach in Level 2 calculations. These changes aim at ensuring Euribor’s long term sustainability by easing Euribor’s panel banks burden and attracting new banks to the panel.”

As investors grapple with a vacillating rates backdrop and high inflation, the depth of Euribor liquidity is set to play a key role in helping them manage market uncertainty.