The European Central Bank (ECB) faces a challenging backdrop as it prepares for its October meeting, with upheaval in France and the Iran war keeping energy prices above $100. This environment raises questions about how to set interest rates amid elevated inflation risks. David Coombs, head of multi-asset investments at Rathbones Asset Management, described the situation as 'incredibly difficult.'
Markets widely expect the ECB to leave its key interest rate unchanged at 2.5% after recent hikes in June and September. Economists polled by Reuters anticipate a quarter-point rate hike in December, reflecting ongoing concerns about inflation. MUFG senior economist Henry Cook noted that the ECB remains 'materially less worried about inflation.'
The ECB is likely to maintain a data-dependent approach, balancing high inflation at 3.8% in September with concerns about rising government bond yields. Barclays' head of euro rates strategy, Rohan Khanna, highlighted the uncertainty around the conflict and energy prices. Core inflation, excluding food and fuel, rose slightly to 2.5% last month, suggesting limited second-round impacts.
French bond selloffs are also a concern, with 10-year borrowing costs hitting 24-year highs above 5%. The premium over German bonds has risen to 170 basis points. While the ECB is monitoring the situation, it is unlikely to act soon with measures like the Transmission Protection Instrument. ECB President Christine Lagarde emphasized that France should address its debt problems through fiscal consolidation.
Succession planning for Lagarde is another topic of interest. Her potential early exit could open a vacancy on the ECB's Executive Board. Frontrunners for her replacement include former central bank governors Klaas Knot of the Netherlands and Pablo Hernandez de Cos of Spain. Analysts noted that a snap Spanish election could impact the politics around ECB succession.