€STR

What it means

€STR, the euro short-term rate, is the euro area's overnight reference interest rate published by the European Central Bank. It is based on actual unsecured overnight borrowing transactions between banks, and the ECB publishes it every business day.

It replaced the older EONIA, which was based on bank quotes and vulnerable to manipulation. Because €STR is transaction-based, regulators regard it as more reliable, and it roughly corresponds to a risk-free rate for very short periods.

Alongside it, EURIBOR reflects rates for longer terms such as three or six months and remains the most common basis for floating-rate loans. €STR is used mainly in derivatives, interest rate swaps and as a fallback rate in loan agreements.

How it works in practice

For ordinary businesses, €STR mostly appears in loan agreements as the fallback rate should EURIBOR cease to exist. Such clauses are required by benchmark regulation and set out how the rate is adjusted to remain comparable.

In hedging interest rate risk with swaps, €STR is often the floating leg. A company with a floating-rate loan can fix its costs with a swap, and the bank values the swap using curves derived from €STR.

€STR closely tracks ECB monetary policy because it stays near the central bank's deposit rate. When ECB rate rises or cuts are expected, €STR moves, followed gradually by EURIBOR and interest on loans and deposits.

What to watch out for

€STR is an overnight rate, so in loans it is compounded over the interest period, for example backward-looking over three months. The interest amount is then known only at the end of the period, not at the start as with EURIBOR, which matters for cash flow planning.

The rate can also be negative, as it was in the years of low interest. Loan agreements therefore often include a zero floor that protects the bank, and when hedging it must be checked whether the swap reflects such a floor, or the hedge may not match.