Lagarde’s Comments Point To A December ECB Rate Hike

Upside risks to inflation and downside risks to growth clearly complicate the ECB's job. However, comments at the press conference suggest the ECB is set to hike again in December.

Rates on hold and Lagarde out. That’s the headline from today’s ECB meeting. But look beyond that, and the message is more nuanced: despite growing stagflationary pressures, the ECB still looks set to hike rates again in December.

The decision to keep interest rates unchanged was not a surprise. The main argument behind this decision is that there are currently few knock-on effects from higher headline inflation, while financing conditions, mainly bond yields, have become more restrictive.

A pause after two rate hikes this year was expected, even if macro developments since the last meeting could have justified another rate hike. Headline inflation increased again in September, and most leading indicators point to continued resilience in the eurozone economy. However, the surge in bond yields on the back of the French crisis is already imposing a new restrictive monetary policy stance. Or in other words, the bond market has taken over the ECB’s job.

According to Christine Lagarde, risks to the eurozone’s growth outlook remain tilted to the downside, while risks to the inflation outlook are tilted to the upside. A combination of risks that clearly complicates the ECB’s path ahead. This dilemma was underscored by her observation that key developments since the September meeting have been a further rise in energy prices and a worsening of financing conditions.

Despite these new complications, the ECB apparently debated a rate hike today. However, the worsening of financing conditions took the option off the table.

Lagarde also emphasised the importance of indirect and second-round effects from higher energy prices. Currently, the ECB is not seeing any additional second-round effects, other than the ones included in the September staff projections.

ECB looks set to hike again in December despite increasing stagflationary pressures

Looking ahead, there are three main parameters that, in our view, will determine the ECB’s path going forward:

1. The length and intensity of the war in the Middle East. The longer oil prices remain elevated, the higher the probability of more rate hikes.

2. The knock-on effects of higher energy prices. So far, there has hardly been any pass-through of higher energy prices in the rest of the economy. If this remains the case, the need for further rate hikes drops. If it doesn’t, the possibility of rate hikes rises.

3. France. Any solution to France's current fiscal woes could bring some relief to bond markets and allow the ECB to continue hiking rates. Without any solution, bond markets have taken over the ECB’s role, making rate hikes less likely (and less needed).

With today’s comments, another rate hike at the ECB’s December meeting is clearly in the offing. It would require a sharp worsening of the growth outlook to probably prevent the ECB from hiking once again.

In short, with downside risks to the growth outlook and upside risks to the inflation outlook, the ECB seems to be increasingly concerned about stagflationary forces, without calling them stagflationary. Remember back in April, Lagarde called ‘stagflation’ a ‘flashy term’.