The majority of analysts expect the European Central Bank (ECB) to choose this Thursday to freeze interest rates, thus chaining together a pause after the 25 basis point increase applied in September. Despite this, market consensus continues to bet on a new restrictive turn in monetary policy before the end of the year.
This Thursday’s ECB meeting comes just after the United States Federal Reserve (Fed) decided yesterday to leave the cost of money unchanged, keeping it in the target range of 3.75% and 4%, following the increase at the previous meeting and in the final stretch toward the midterm elections --'midterms'-- in the North American country.
In the eurozone, the outlook is complicated by inflation at a three-year high, which reached 3.8% in September after rising six tenths in just one month; by the rebound in sovereign debt yields of the major economies, with France under special scrutiny for its budgetary imbalances, and by high political uncertainty that has led to strong protests in different European states.
In this scenario, the european central bank would opt to keep the cost of money at current levels at this Thursday’s meeting. Thus, the deposit rate (DFR) would remain at 2.5%, that of the main refinancing operations (MRO) at 2.65% and that of the marginal lending facility (MLF) at 2.90%, with the intention of gaining room for maneuver and arriving at the December meeting with a clearer diagnosis.
"A rate hike would be a big surprise. The probability is practically zero, since inflation has remained contained, France has prompted a downward revision of prices and President Christine Lagarde has shown herself somewhat less bellicose," have indicated ING Think analysts Francesco Pesole, Michiel Tukker and Carsten Brzeski.
Underlying inflation in the euro area, which excludes energy, fresh food, alcohol and tobacco, stood at 2.5% in September, with an increase of only one tenth, a reading that suggests that second-round effects are still not clearly being observed in the bloc’s economy.
"Although we are currently observing higher inflation, there are still no signs that it is being incorporated on a lasting basis. The indirect effects remain contained and second-round effects are not evident," explained Pimco portfolio manager Konstantin Veit.
Increasing pressure on French debt
France is suffering ever greater pressure in the bond markets, with the yield on the ten-year bond having recently surpassed 5%, its highest level since 2002. Investors are thus demanding a higher interest rate to finance the French State, in a context of concern about the sustainability of its public accounts. This tension is also reflected in the country’s risk premium, with the spread between the French and German bond (Bund) around 160 basis points.
"The tightening of financial conditions reinforces the arguments in favor of a pause, and downside risks are increasing. Long-term yields have risen considerably and sovereign debt spreads have widened, especially in France, which has led to a tightening of financial conditions across the euro zone," said Josefina Rodríguez, economist at Vanguard.
Natixis IM analysts, Mabrouk Chetouane and Romain Aumond, consider it likely that Lagarde will make an explicit reference to the situation in France at the press conference after the meeting, which would amount to "a sign that the central bank is taking the volatility affecting fixed-income markets seriously".
"Without needing to activate the anti-fragmentation instruments, the recognition of these risk factors, on the one hand, and the suspension of the quantitative tightening process, on the other, would send strong signals from the ECB, aimed at containing the pressures on sovereign debt markets," he stated.
Markets awaiting a rise in December
Even so, instability in French bonds and those of other European issuers does not seem sufficient for the ECB to abandon its restrictive cycle, begun in May after the start of the Iran war, and markets are already pricing in another increase in the cost of money in December.
"In this scenario we are pricing in another additional rate hike at the December meeting, which would take the deposit facility to 3% by the end of 2026. From here, and looking ahead to 2027, the evolution in the growth and price data that we learn about will be key to talking about further hikes," said Cristina Gavín, head of Fixed Income at Ibercaja Gestión.
The experts expect Lagarde’s speech to deviate only slightly from her previous messages and to reiterate her determination to keep inflation in check, thus providing investors with guidance on possible additional adjustments to monetary policy.
"It is likely that Christine Lagarde will reiterate that the risks to inflation remain tilted to the upside and the risks to growth to the downside, while highlighting the resilience of the European economy," said François Rimeu, senior strategist at Crédit Mutuel AM.