The ECB Plans One More Rate Hike in December, Then a Pause Because Bond Markets Already Did the Tightening

The European Central Bank held rates on Thursday, but its policymakers already seem to know their next two moves: one more hike in December, then a long look at what bond markets have done for them.

Three policymakers told Reuters after the meeting that a hike on December 17 is all but certain unless energy prices suddenly collapse. It would lift the deposit rate to 2.75% from the 2.50% set in the September increase. After that, they expect to stop. An ECB spokesperson declined to comment.

Markets did part of the job

The reason for the pause is a set of internal estimates that circulated before the meeting. They show the recent rise in bond yields will lower growth by a cumulative 100 basis points and inflation by 90 basis points across 2027 and 2028, compared with the ECB's September projections.

In other words, investors demanding higher yields have already delivered tightening the central bank would otherwise have to deliver itself. The ECB's own statement acknowledged as much in gentler language, saying financing conditions have tightened since the last meeting and are likely to weigh on inflation and growth.

France shows how uncomfortable that mix can get. Its economy shrank 0.1% in the third quarter while inflation climbed to 3.4%, leaving Paris with weak growth and high prices at once.

A hold that sounded like a warning

Thursday's decision to stand pat was unanimous, but it came only after a debate about hiking. The premise was that the energy driven surge in inflation is not yet causing dangerous second-round effects. The statement warned that rising energy prices pose upside risks to inflation and downside risks to growth.

Officially, nothing is decided. "We are not pre-committing to a particular rate path," the statement said.

ECB President Christine Lagarde then went through a long list of what arrives before December: new staff projections, two inflation prints, third quarter GDP, wage data, two unemployment readings, November PMIs and bank lending statistics. If the situation that "could have warranted a hike" is confirmed, she said, "the sense of direction is quite clear." For a central bank that refuses to pre-commit, that came close.

Rome wants the door left open

Not everyone appears ready to talk about stopping. On Friday, Bank of Italy Governor Fabio Panetta argued that policy must keep price increases from becoming entrenched in the behaviour of households and firms, setting off a wage-price spiral "that would be costly to stop."

"With inflation set to remain above target for an extended period and risks skewed to the upside, further increases in the policy rates could prove necessary," he said.

Investors sit somewhere else again. LSEG data shows markets giving about a two in three chance of a December hike, which is less sure than the policymakers who spoke to Reuters. Further out, they are far more aggressive, pricing almost three increases over the coming year on top of the two hikes already delivered this year.

That gap is the story to watch. Policymakers are describing one more move and a pause, while traders are pricing nearly three. Between now and December 17, energy prices will do much to decide which side has it right.

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