When Cheap Money Is Called Back

Europe’s economy is barely growing, Germany faces economic problems, and the state keeps taking on new loans. This would seem an environment in which low interest rates were welcome. Yet precisely now the European Central Bank is raising its policy rates. On 10 September 2026, the Governing Council decided on a 25-basis-point increase. Effective 16 September, this raises the deposit rate to 2.50 per cent, the main refinancing rate to 2.65 per cent and the marginal lending rate to 2.90 per cent. The ECB cites persistent inflationary pressure. It expects average inflation of 3.0 per cent in 2026 while forecasting just 0.9 per cent growth for the euro area.

This is an uncomfortable combination. A central bank faces two problems: fighting inflation with higher rates makes loans more expensive and burdens businesses, property markets, consumers and governments. Cutting too soon instead risks renewed price pressure. Higher rates can restrain demand, but they neither create additional energy nor directly remove the causes of a supply shock.

Behind visible monetary policy, however, lies a second story. A story about capital flows, currencies and how long states and financial markets can rely on cheap financing. It begins not in Frankfurt or Washington, but in Tokyo.

The financial trade behind cheap money

For a long time, Japan was an exceptional source of financing. Low Japanese interest rates made the yen the funding currency for one of international finance’s best-known strategies: the yen carry trade. The principle is simple. An investor borrows in a low-interest currency, then invests where higher returns beckon. Yen become dollars or euros used, for example, to buy American or European securities.

As long as the interest differential remains large enough and the yen does not appreciate sharply, this strategy can deliver returns. Such trades are frequently leveraged, however, through additional borrowing or corresponding derivatives positions. Relatively small changes in interest rates and exchange rates can therefore have substantial effects. The yen was not only a currency, but a funding source for the global financial system.

What happens when the direction changes?

When Japanese financing becomes more expensive and rate differentials with other currency areas narrow, carry trades lose some appeal. A strengthening yen is even more dangerous for investors. Eventually, the borrowed yen must be repaid. Anyone borrowing yen, exchanging them for euros and buying European securities has an open currency position unless appropriately hedged. If the yen rises significantly, repayment becomes more expensive in euros. An apparently predictable interest-rate strategy can turn into a loss.

That is precisely why carry trades can reverse quickly. Investors sell their assets, buy yen back and close positions. This can push the yen higher still, pressuring additional investors to sell too. A quiet financing strategy becomes a feedback loop. A study by the Bank for International Settlements, or BIS, describes how large speculative positions against a funding currency can amplify exchange-rate responses to monetary-policy changes.

A preview was visible in August 2024. Unwinding leveraged equity and currency positions amplified markets’ response to disappointing US economic data. Carry trades came under considerable pressure. Markets subsequently stabilised, but the episode showed how quickly many similar individual decisions can become collective selling.

Why Europe should pay attention

The decisive issue is not merely whether some hedge funds lose money. Initially, that would be their problem. What matters is where the capital was invested and what happens when many investors reduce positions simultaneously. There is also a second, distinct relationship: Japanese banks and institutional investors hold substantial foreign-currency investments. Not every such holding is a speculative carry trade.

If domestic assets become more attractive, those investors’ calculations may change. Why accept extra currency risk or hedging costs if an adequate return is available at home? This creates a possible scenario: if less capital flows into foreign sovereign bonds, or existing capital is repatriated, issuers may have to offer higher yields to attract other buyers. This is not inevitable, but a possible transmission channel between financial markets.

For Europe, such a shift would be particularly uncomfortable if it coincided with growing financing needs. The question of the terms on which capital is available extends beyond investment funds. It reaches government budgets.

Governments need buyers

Public debt is usually discussed politically. Something crucial is often forgotten: debt must be financed. A state can approve additional borrowing, but its bonds need buyers — banks, insurers, pension funds, investment funds or foreign investors, for example. With sufficient demand, this works largely without drama. It becomes harder when additional bonds meet investors demanding higher yields or seeing more attractive alternatives.

Germany is an interesting example. The government’s draft federal budget for 2027 provides for around €118.7 billion in net borrowing in the core budget alone. Added to that is debt-financed spending through special funds for infrastructure and climate neutrality and for the Bundeswehr. Anyone discussing total new federal borrowing must distinguish these areas and then combine them transparently. Core-budget borrowing is not equivalent to all federal debt financing.

The problem is not automatically today’s debt ratio. When presenting the draft budget, the Finance Ministry expected Germany’s general-government debt to reach roughly 66.5 per cent of GDP at the end of 2026. That would still place Germany well below the euro-group comparison figure. This number alone therefore cannot establish an imminent financing collapse. Another question is more interesting: what will this debt cost in future?

Interest returns to the budget

The interest bill shows how much the burden can change. For 2027, the “Federal Debt” budget section provides around €41.8 billion for debt service, compared with about €30.2 billion in 2026. That is an increase of more than €11 billion. In its financial planning, the government largely attributes the growing burden to higher debt and increased yields on federal securities.

Public debt is not immediately refinanced in full at new terms. Existing bonds mature gradually. Consider an old federal bond paying 0.5 per cent: if it matures and is replaced with financing at three per cent, the debt stock initially stays unchanged. But the annual interest bill on the refinanced amount rises substantially. This effect can work its way through budgets over several years.

Fiscal pressure begins here. Other things equal, every additional euro spent on interest is unavailable for other spending. Infrastructure, social provision, defence, tax cuts and public investment then compete within narrower room. The burden need not emerge through a spectacular break. It can build gradually as each year requires more money to finance past decisions.

When capital demands a price again

The idea of almost unlimited capital is seductive: when the economy weakens, interest should fall. When financial markets face pressure, extra liquidity should help. When governments want to spend more, buyers for their bonds should remain available. Yet an expectation does not become a guarantee.

Perhaps this is the larger change. Not that the financial system collapses tomorrow, but that capital becomes more selective again. Investors ask: what return am I getting? What risk am I taking? Which currency am I holding? Is there a better opportunity elsewhere?

This sounds obvious. But for debtors whose calculations work only with permanently low financing costs, even such normality would be a substantial challenge. The decisive question becomes not merely whether a project is politically desired or economically interesting. It must remain viable under changed financing conditions too.

Is the ECB rate increase a rescue for carry trades?

A clear distinction is needed here. In the interview with Thomas Kolbe, he argues that higher European interest rates could also help support the yen carry trade. A larger yield differential would, in this interpretation, retain capital in the euro area and slow the unwinding of positions. This is Kolbe’s interpretation of the interaction between monetary policy and capital flows.

It is not, however, an established motive for the current ECB decision. The central bank grounds its decision in its inflation mandate and persistent price pressure resulting from the Middle East conflict. Possible effects of a rate rise on carry trades do not automatically establish their stabilisation as its true purpose.

Nevertheless, a central bank does not decide in a vacuum. Exchange rates change import prices, financing conditions affect investment, and monetary-policy expectations influence bond yields and other asset prices. Monetary policy is therefore not merely the isolated question of today’s inflation rate. It works through a network of expectations, loans, currencies and capital markets.

The real pressure arises in bond markets

Politicians can approve budgets, parliaments create special funds and governments announce investment programmes. That does not answer the price of those decisions. While a state funds itself through markets, it must accept the terms on which investors are willing to supply capital.

This does not mean financial markets are always right or that every public investment must first satisfy short-term return expectations. It does mean political decisions cannot suspend financing costs. Anyone wanting to borrow more must consider how it will be serviced and what economic capacity stands behind it.

That is why the relationships surrounding the yen are so interesting. They show that capital’s price is not formed solely within national borders. Changed financing conditions in one currency area can affect positions and decisions elsewhere. Carry-trade experience makes this connection especially clear.

Perhaps this is the more important story behind the current rate debate: not one increase of 0.25 percentage points, but how resilient an economic system is when its participants rely on permanently cheap refinancing. A funding source need not dry up entirely. Sometimes becoming more expensive and less reliable is enough.

And then there is Bitcoin

This is where Bitcoin becomes particularly interesting to me. Not because Bitcoin automatically rises when central banks make mistakes, nor because sovereign bonds will be worthless tomorrow. Rather, Bitcoin represents a different monetary construction: new units are issued according to defined rules rather than ongoing central-bank decisions. Under the current rules, total supply is limited to approximately 21 million bitcoin.

With the euro, central bankers debate the appropriate interest rate. With the yen, the issue is the conditions and consequences of Japanese monetary policy. With government bonds, governments and parliaments decide how much new debt to issue. Bitcoin, by contrast, has no central body that can decide at a meeting to create extra units because growth is weak or a bond market needs support. Rule changes cannot simply be imposed unilaterally on network participants.

This does not make Bitcoin risk-free. Its price can fluctuate sharply, and limited supply guarantees neither rising prices nor purchasing-power preservation at every possible moment. But its monetary rules are not designed to solve a state’s most pressing financing problems at any given time.

In a world where high debt meets sensitive capital markets, this property could become more important. Not as a promise of effortless prosperity, but as a fundamental difference between a politically directed monetary system and a network with rule-bound issuance.

Perhaps we are therefore not simply experiencing another round of the usual interest cycle. Perhaps we are watching something more fundamental: capital is acquiring a price that cannot permanently be argued away. When that happens, governments, businesses and investors must relearn what cheap financing can push into the background: money is not free. Debt is not free. And trust is not free either.