ECB rate decision on Thursday: Plenty of friction in the path of rate hikes
Summary
- The ECB is expected to maintain its policy rates unchanged on Thursday, despite rising energy prices driving inflation, as price pressures have not significantly spread to other goods.
- French government bond yields have risen sharply, reflecting concerns over the country's deficit and debt, while long-term yields in other eurozone countries have also increased, raising financing costs and dampening demand and inflation.
- Eurozone inflation rose to 3.8% in September, primarily due to energy prices, with the ECB cautious about potential second-round effects and awaiting early-year wage negotiations before considering further rate hikes.
- The ECB is mindful of past mistakes, such as the 2011 rate hikes that worsened the crisis, and may signal a slower pace of rate increases to ease pressure on French yields, while President Lagarde is expected to emphasize the central bank's tools to manage broader risks.
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Automatic translation: Originally published in Finnish 28/10/2026, 05:47 GMT. Give feedback here.
The ECB is expected to keep its policy rates unchanged on Thursday. Energy prices have pushed up inflation, but price pressures do not appear to be spreading significantly to other goods. At the same time, the central bank is careful not to add pressure to French government bonds.
The ECB raised interest rates in September for the second time since the US-Iran war sharply drove up energy prices. Since then, French government bond yields have risen to levels not seen since the early 2000s. Long-term yields in other eurozone countries have also risen, albeit to a more moderate degree. Consequently, financing costs for households and businesses have increased without additional central bank measures, which is dampening demand and inflation. ECB Executive Board member and Chief Economist Philip Lane has also emphasized that the rise in long-term yields dampens economic activity and slows inflation over the medium term.
Eurozone inflation accelerated to 3.8% in September from 3.2% in August. However, the increase was mainly driven by energy, while the rise in industrial goods prices slowed down. It is still too early to draw conclusions about so-called "second-round effects", i.e., the broad-based escalation of price increases. The majority of Eurozone wage negotiations take place early in the year, by which time households will have already seen potential increases in winter heating bills. The December meeting will be held just before the wage negotiations begin.
The rise in French yields reflects concerns that the country lacks a credible plan to curb its large deficit and rapidly growing debt. If interest rates remain high, the government's interest expenses will increase, making it even more difficult to reduce the deficit. The ECB could ease the pressure by signaling that rate hikes will continue more slowly than the market expects. However, it cannot completely sweep France's problems under the rug.
The ECB has lessons to learn from history. In 2011, the central bank raised interest rates twice due to rising energy prices, even though the situation in the fixed-income markets was challenging at the time. The decision deepened the crisis, and the hikes had to be reversed. Confidence did not return until 2012, when Mario Draghi promised to do whatever it takes to save the euro. Now, the French yield spread does not yet require intervention, and contagion has not spread widely to other eurozone countries. We expect President Lagarde to remind the market of the tools available to the central bank to contain broader risks. It is quite possible that the ECB will keep interest rates unchanged in December as well and wait for evidence from early-year wage negotiations before making new hikes.
