A tightening already under way
For several weeks the working assumption has been that the European Central Bank would keep lifting rates. It has already increased them twice in four months, and a further move in December was widely anticipated as the bank tries to contain inflation driven by energy costs. That expectation is now harder to sustain, because a separate force is pushing borrowing costs higher.[S1]
The turmoil in bond markets is lifting the cost of credit independently of anything the ECB does with its policy rate, and it is simultaneously cooling the economy. As bonds are sold off and yields climb, the case for adding another rate increase weakens, which leaves open the question of whether the bank will act in December at all.[S1]
What the yield surge has already done
Carsten Brzeski, who leads global macro research at ING, argued that circumstances have shifted since the September meeting. He estimated that the rise in German bond yields since then has delivered an effect on growth and inflation comparable to an extra quarter-point increase in rates. For France, he put the equivalent closer to half a percentage point.[S1]
Brzeski added that with bond markets effectively performing the central bank's tightening for it, some officials may feel less inclined to keep raising rates than they did in September. His remarks point to a debate inside the institution about how much of the restraint is already being supplied by investors rather than by policy.[S1]
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Lagarde points to financing conditions
Christine Lagarde, the ECB's president, made a similar case on Saturday. She observed that the current bond sell-off was making borrowing dearer across the euro zone, restraining economic expansion and, in time, inflation. She was speaking to central bankers and finance ministers who had gathered in Bangkok.[S1][S2]
Lagarde noted that although growth had held up, financing conditions had become tighter, with long-term interest rates climbing markedly since the bank's previous meeting. She said this would slow growth and reduce pass-through by more than the bank had projected in its September exercise.[S1]
The December arithmetic
Should the ECB decide on another quarter-point increase in December, its policy rate would stand at 2.75 per cent. Financial officials describe that level as restrictive, meaning it curtails economic activity. The inflation outlook is being watched closely, particularly the second-round effects on food and other items, which have not yet appeared.[S1]
