ECB Expected to Hold Rates Steady Tonight; French Bond Turmoil and Energy Price Rises Are Key Considerations

The ECB will announce its interest rate decision at 21:15 Beijing time on Thursday, and the market widely expects the bank to hold steady as it weighs the impact of French bond market turmoil and renewed rises in energy costs. Surveys show that all but one economist expect the ECB to keep the deposit rate at 2.5% on Thursday. Economists predict the ECB will deliver a third and final rate hike in December. New economic projections at that time will provide guidance on the path of consumer prices through 2028, while further disruptions to oil and gas supplies from the Iran war continue. Although inflation is still nearly twice the 2% target, the fact that it remains concentrated mainly in energy gives policymakers greater room for maneuver when considering their next move. Meanwhile, the euro area economy, which has so far proven resilient, is losing momentum. Officials have warned that the recent surge in sovereign bond yields will weigh on economic growth, although it also helps curb inflation. However, France faces more severe market pressure due to high budget deficits and street unrest. The plight of the euro area's second-largest member state recalls the European debt crisis more than a decade ago, fueling speculation over whether the ECB will intervene or whether it will be more inclined to refrain from further monetary tightening. This week, the Federal Reserve chose to keep rates unchanged, and the ECB and the Bank of Japan are also expected to hold steady. ECB President Lagarde will hold a press conference at 2:45 p.m. Frankfurt time (30 minutes after the policy statement is released) to answer reporters' questions on these issues and on her own future. Rate Path Some ECB officials have signaled that further action is likely as inflation approaches 4%. Holding steady this week and raising rates in December would both maintain the quarterly tightening pace and show that policymakers are not panicking. Lagarde and others have said they still believe "prudent" adjustments are the best approach. But they also stressed that the situation remains uncertain and that the consumer price outlook depends largely on developments in the Middle East. ECB Governing Council member Pierre Wunsch said this month: "Market pricing reflects that we may have to do more. That is a baseline scenario that looks reasonable, but we are still in a very uncertain world." Rates are currently at the upper end of the so-called neutral rate range. Moving them clearly above that threshold may require evidence of second-round effects, such as rising wage demands, indicating that inflation is becoming more entrenched. Data have been relatively sparse since the last meeting in September, with a new batch due only on Friday when Eurostat will release its third-quarter economic growth report and the four largest economies will publish October inflation data. France's Plight Investors are closely watching how Lagarde will respond to the turmoil in the French bond market, especially given that the turmoil has spread to other countries such as Italy. The spread of French 10-year government bond yields over Germany's recently surged to a 15-year high, and the country is struggling with a budget gap, political fragmentation and social unrest. The situation could put the ECB in a dilemma, because its crisis-response tools are not designed to address excessive deficits in EU member states. ECB officials have dismissed the idea that they may have to use the so-called Transmission Protection Instrument (TPI). Created in 2022, the tool allows the ECB to conduct unlimited bond purchases in the event of unwarranted and disorderly market volatility. Another option is to pause quantitative tightening. The ECB has been shrinking the bonds it bought during the low-inflation period. So far, there is no sign that this would win support from the Governing Council. "The bar for action will be very high," said Nannette Hechler-Fayd'herbe, chief investment officer for EMEA at Lombard Odier. "Unless there is a real risk of contagion that causes financial market disruption or a tightening of liquidity across the EU, I don't think the ECB will use tools like the TPI." Lagarde's Future Rumors about Lagarde stepping down early as ECB president continue to swirl, especially after she confirmed she is considering leaving "a few months" before her term ends in October next year. Other rate-setters increasingly want her to clarify the situation, and there is a widespread view within the euro area that she will leave in January next year. That means she must make an announcement as soon as possible so that EU leaders have enough time to choose a successor.