Bond markets have already tightened financial conditions by an amount analysts put at the equivalent of 25 to 50 basis points of rate increases. Yet, after raising interest rates in September, the European Central Bank still faces the prospect of another increase on 17 December.
The immediate decision appears clearer. Most analysts expect the ECB to leave rates unchanged at its meeting on 29 October. A December rise remains a distinct possibility.
The pressure is visible in France. French 10-year government bond yields topped 4.9% in the week before 15 October. The gap between French and German 10-year yields approached 150 basis points, its widest level since late 2011 during the euro crisis.
By 15 October, that spread had eased to about 141 basis points.
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Carsten Brzeski, ING’s global head of macro, said the rise in German bond yields since the September meeting had an effect on growth and inflation equivalent to a further 25 basis point rate increase. For France, he put the effect closer to 50 basis points.
That leaves the ECB confronting tighter conditions already imposed by markets as it considers whether to add to them itself. Brzeski said some officials may be less willing to keep raising rates than they were at the September meeting because bond markets are already doing part of the central bank’s work.
Nicolò Bragazza, an associate portfolio manager at Morningstar Wealth, said a weaker inflation outlook could put the ECB in a difficult position. It would have to weigh its mandate to return inflation to its 2% target against the risk that higher sovereign yields and market fragmentation damage financial stability and hinder the transmission of monetary policy.
Ulrike Kastens, a senior economist at DWS, said another two or three rate increases no longer fit the current economic picture.
Energy costs are feeding into producer and consumer prices. There is, however, little evidence so far that they have set off a broader cycle of wage and price increases.
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