On Thursday local time (the 29th), the European Central Bank announced it would keep its three key interest rates unchanged, maintaining the deposit facility rate at 2.50%, the main refinancing rate at 2.65%, and the marginal lending rate at 2.90%, in line with market expectations.
This marks the ECB's first pause after raising rates by 25 basis points in September.
Since the start of this year, the ECB has raised rates twice, in June and September, for a cumulative 50 basis points.
Following the decision, rate-sensitive two-year eurozone government bond yields fell further.
The euro weakened briefly before rebounding, and as of Thursday evening European time, the euro was up 0.08% against the dollar.
Data from London Stock Exchange Group (LSEG) shows money markets see about a 67% probability of an ECB rate hike in December.
European stocks rose across the board.
Germany's DAX index closed up 1.31%, France's CAC 40 closed up 1.05%, the pan-European STOXX 600 closed up 0.77%, and the UK's FTSE 100 closed up 0.26%.
Governing Council discussed a rate hike
In its monetary policy statement, the ECB said persistently rising energy prices pose upside risks to the inflation outlook and downside risks to the growth outlook.
The full impact of the energy shock is still unfolding, but underlying inflation is now broadly stable and wages have not yet shown a substantial response.
The statement also warned that a larger and more prolonged energy shock, along with its indirect and second-round effects, is likely to push inflation higher and weigh on growth.
According to Eurostat data, the eurozone's harmonized index of consumer prices (HICP) rose 3.8% year-on-year in September, up from 3.2% in August and the highest since September 2023.
Energy prices rose 18.9% year-on-year, while core inflation, excluding energy, food, alcohol and tobacco, rose 2.5% year-on-year.
ECB President Christine Lagarde said at a subsequent press conference that the Governing Council discussed whether a rate hike was appropriate at this meeting.
She explained that since the September meeting, energy costs including oil, gasoline, fuel and natural gas have risen, and long-term financing costs have also increased significantly.
But "given the accumulating and rising uncertainty, and broadly unchanged underlying inflation," the Governing Council unanimously agreed that there are currently sufficient conditions to hold steady and that a prudent approach remains appropriate.
In response to a reporter's question, she said, "At present we do not see second-round effects beyond what was already incorporated in the (September) projections."
Regarding the December policy meeting, she said the next six weeks "will bring a wealth of information" that will help determine whether "the situation that might require a rate hike" is confirmed, and "if so, the direction is fairly clear."
Bond market "tightening on behalf of the central bank"
Recent sharp fluctuations in the European bond market were another important factor behind this pause.
The ECB statement specifically noted that financing conditions have tightened since the last policy meeting, with market-based debt financing costs and mortgage costs rising, which could weigh on inflation and growth.
Lagarde said the average yield on 10-year eurozone government bonds has risen by about 35 basis points.
She believes the rise in long-term yields is a global phenomenon, reflecting both inflation and interest rate expectations, and also linked to large technology companies issuing substantial debt to raise funds.
Internal ECB estimates show that compared with the September baseline projections, the recent rise in European bond yields will reduce cumulative economic growth and inflation in 2027 and 2028 by 100 basis points and 90 basis points, respectively.
France is where the pressure is most concentrated.
Affected by rising debt and political uncertainty, the spread between French and German 10-year government bond yields briefly approached 178 basis points last week, near a 15-year high, before narrowing to around 150 basis points on Thursday.
The ECB statement did not name France, but stressed that "fiscal sustainability is a critical anchor" and that fiscal measures to address the energy shock should be temporary.
Lagarde also avoided naming names but said highly indebted countries must take into account when formulating fiscal plans that interest rates have already risen and may remain elevated for some time, and that such plans must comply with EU fiscal rules.
She also reiterated that "if market dynamics threaten the smooth transmission of monetary policy, including unreasonable and disorderly market fluctuations, we have tools to address them."
Rate hike cycle not yet over
In the view of Mark Wall, chief European economist at Deutsche Bank, although the ECB kept rates unchanged this time, it sent a signal that a December rate hike is "clearly under consideration."
He believes the previous two rate hikes and the tightening of financing conditions since September "may not be enough" to withstand a further rise in energy inflation risks.
He expects the ECB to raise rates once more at its December meeting during Lagarde's tenure, lifting the deposit facility rate by 25 basis points to 2.75%, "which is likely to be the endpoint of this rate hike cycle."
Dean Turner, chief eurozone and UK economist at UBS Global Wealth Management, believes this decision "should be seen as a hawkish pause, not the end of the tightening cycle."
He believes that, absent broader financial stress, France's fiscal challenges are not expected to change the direction of ECB monetary policy.
Carsten Brzeski, global head of macro at ING, said that based on Lagarde's latest remarks, another ECB rate hike at the December meeting is "clearly in the making," and unless the growth outlook deteriorates sharply, the ECB is likely to raise rates again.
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