ECB – Lagarde's dual message

Everything points to a rate hike in December, …

To the surprise of most observers, ECB President Christine Lagarde said that the Governing Council had discussed an interest-rate hike at today’s meeting. In this context, she referred to the recent sharp rise in energy prices and thus inflation risks. These could have justified a rate hike, Lagarde said. Ultimately, however, the Council unanimously decided against raising rates. For the next meeting in December, though, she signaled a rate hike: “The direction of travel is quite clear.” Like most economists, we expect a rate hike in December.

… but, because of France’s fiscal crisis, Lagarde dampened rate hike expectations

However, this was not Lagarde’s entire message. Both in the statement and during the press conference, she stressed that the recent increase in bond yields had tightened financial conditions (chart), which in itself would point to weaker growth and lower inflation. In doing so, she indirectly alluded to the French fiscal crisis, which could potentially destabilise the monetary union if it were to escalate. Lagarde’s indirect message was that markets should not price in too many rate hikes because of France. She is likely aware that French bonds, given France’s high debt levels, benefit twice as much as German government bonds from declining rate hike expectations.

The fact that France’s fiscal crisis played an important role in the ECB’s thinking was also evident from Lagarde’s remark that the ECB has instruments to prevent unwarranted and disorderly movements in bond markets. She was referring to the TPI bond-purchase programme.

For full text see attached PDF-Version.