Frankfurt: For most of the past two years the European Central Bank’s Governing Council met to decide how much to cut. On 10 September it met and raised, taking all three key rates up by 25 basis points. The deposit facility rate became 2.50 per cent with effect from 16 September, and the main refinancing rate moved to 2.65 per cent.
Twenty-five basis points is a small number and the direction is the whole story. A central bank that has spent a cycle easing has an institutional stake in the coherence of its own narrative, and reversing costs it something. The Council’s stated reason is that inflation is now expected to stay well above the two per cent objective for an extended period, with pressure attributed in part to the continuing conflict in the Middle East and its transmission through energy and shipping costs.
That framing puts the decision in the most difficult category a monetary authority faces. A supply shock raises headline inflation while reducing output, and the textbook response is to look through it, provided expectations stay anchored. Tightening into a supply shock deepens the contraction it is responding to. The judgement the Governing Council has evidently made is that the shock has run long enough, and fed far enough into services prices and wage settlements, that looking through it risks the anchor. Whether that judgement is right will not be established by the October data.
The distributional arithmetic inside the euro area complicates it further. A single policy rate lands unevenly across twenty countries with different mortgage structures, different debt maturities and different fiscal positions. Households in Spain, Portugal, Finland and Ireland hold a high share of variable-rate mortgages, so a 25 basis point move reaches their monthly payment within a quarter. German and French borrowers, predominantly on long fixed terms, will barely notice. Sovereign issuers with heavy near-term refinancing schedules feel it faster than those who termed out their debt during the low-rate years. None of this is new, and none of it is something the Governing Council can address with the instrument it has.
Bank funding is the other transmission channel worth watching. A higher deposit facility rate raises the return on excess reserves, which supports net interest margins but also makes it more attractive for banks to hold reserves than to lend. Credit growth in the euro area had only recently begun recovering from the previous tightening cycle, and supervisors will be reading the October bank lending survey for signs that the recovery has stalled. The interaction with commercial real estate exposures, which several national authorities have flagged, gives that reading additional weight.
The market question is whether September was a single insurance move or the opening of a sequence. The Council did not commit itself, restating the data-dependent, meeting-by-meeting formula that has served it through both directions of the cycle. Forward pricing after the announcement was consistent with roughly one further increase over the following year rather than a sustained climb, which suggests investors read the decision as a defensive adjustment rather than a regime change.
The next opportunity to find out is 29 October. Between now and then the Council receives September and October flash inflation estimates, a new round of national accounts, and whatever the Middle East supplies. On the evidence of this month, the balance of risk the Governing Council is weighing has shifted from growth back towards prices, and it has decided to say so with an instrument rather than a speech.
