On Thursday, October 29, the European Central Bank's Governing Council announced that it would maintain its three key interest rates unchanged after a two-day policy meeting: the deposit facility rate at 2.50%, the main refinancing operations rate at 2.65%, and the marginal lending facility rate at 2.90%. Previously, the bank had raised these rates by 25 basis points in June and September respectively. During the same period, the Eurozone's harmonized index of consumer prices (HICP) rose to 3.8% year-on-year in September, the highest level in three years, with the energy component rising by approximately 18.8% to 18.9% year-on-year, becoming the main driving factor. Core inflation remained around 2.5%. On the same day, President Christine Lagarde informed the Governing Council and the President of the European Council that she would step down on February 7, 2027, about nine months earlier than her originally scheduled term ended in October 2027. The market is also focused on the asymmetric impact of continued rising energy prices on inflation and growth, the further tightening of financing conditions since the last meeting, and the policy transmission disruptions caused by the widening spreads on sovereign bonds of some member states.

The policy logic and data-dependent framework for keeping interest rates unchanged

The European Central Bank (ECB) stated that continued rising energy prices pose upside risks to the inflation outlook and downside risks to the growth outlook. The full effects of the energy shock are still unfolding; underlying inflation remains broadly stable, and wages have not yet shown a substantial response. However, the magnitude and duration of the shock, as well as the potential transmission of indirect and second-round effects, are expected to push up inflation and dampen growth. Financing conditions have tightened since the last meeting, a change that itself could weigh on inflation and growth. The Governing Council emphasized that it will continue to determine the appropriate monetary policy stance through a data-dependent, meeting-by-meeting assessment approach, with interest rate decisions based on assessments of the inflation outlook and its risks, taking into account economic and financial data, underlying inflation dynamics, and the strength of policy transmission. The statement also reiterated that it does not pre-commit to a specific interest rate path. Within this framework, maintaining the current interest rate reflects the need to observe the effects of previous rate hikes. The ECB's objective is to stabilize inflation at 2% over the medium term, and the current policy mix needs to balance preventing the energy shock from solidifying with avoiding excessive tightening. The asset purchase program and the Pandemic Emergency Purchase Programme (PAEP) continue to be scaled back at a measurable and predictable pace, as the Eurosystem no longer reinvests the principal of maturing securities. The Management Committee also stated that it is willing to adjust all tools within its authority to ensure the achievement of medium-term goals and maintain smooth policy transmission. Transmission protection tools can still be activated when unfounded and disorderly market dynamics pose a serious threat to the transmission across the region.

The transmission mechanism of energy shocks and the divergence in inflation prospects

The sharp year-on-year increase in energy prices in September was the core driver of rising inflation. Energy accounts for about 9% of the Eurozone price basket, and its high single-digit to double-digit annualized changes contribute significantly to the overall reading. Underlying inflation and wage indicators do not currently show a strong second-round effect, providing some room for a policy pause. However, the statement points out that the scale and duration of the shock have increased, and indirect effects may gradually emerge. If energy prices remain high, the transmission of production and transportation costs will prolong the path of inflation decline. The ECB has previously responded to Middle East-related energy supply disruptions with two interest rate hikes. This pause is not a shift towards easing, but rather a wait for more data to verify whether the shock has spread to a broader range of prices and wages. Lagarde has pointed out on related occasions that rising long-term interest rates have had additional effects on growth and inflation transmission, exceeding the extent assumed in the September forecast. Tightening financing conditions themselves constitute an automatic stabilizing mechanism, but may also amplify downward pressure on growth. Current Eurozone growth forecasts are relatively moderate, and the energy shock further limits demand elasticity. Policymakers need to distinguish between temporary supply shocks and persistent overheating demand; the latter requires more sustained tightening. Stable underlying inflation and limited wage responsiveness have reduced the urgency for immediate further action, but the continued rise in the energy sector still carries an upside risk bias.

The Transmission Effect of Tightening Financing Conditions and Sovereign Bond Spreads

The statement explicitly points out that financing conditions have tightened since the last meeting, which is expected to put pressure on both inflation and growth. Rising yields and widening spreads on sovereign bonds in some member states have already pushed up borrowing costs for households and businesses. The spread between French bonds and the German benchmark recently widened to near levels seen during the 2011 crisis, with the 10-year yield reaching approximately 5%, reflecting concerns about fiscal sustainability and political uncertainty. Such widening spreads affect the real economy through bank funding costs and credit standards, constituting an additional constraint on policy transmission. The ECB's bank lending survey previously showed further net tightening of credit standards and weakening loan demand, consistent with the current financing environment. If widening spreads persist, they will exacerbate the asymmetry in policy transmission, causing a differentiated effect of a unified policy stance across different member states. The existence of transmission protection tools provides a potential means to address disorderly market dynamics, but their activation requires strict conditions, including confirmation that market dynamics are unfounded and pose a serious threat to transmission. The Governing Council currently emphasizes that the primary response remains the fiscal arrangements of member states themselves, rather than direct central bank intervention. The continued shrinking of the balance sheet, coupled with unchanged interest rates, creates tighter financial conditions, which dampens demand and allows time to observe the second round of effects.

Leadership change and policy continuity considerations

Christine Lagarde announced her resignation on February 7, 2027, and the Governing Council thanked her for her contributions in a statement, giving her a long standing ovation. In her related remarks, she stated that she was leaving with a sense of accomplishment and that the institution was ready for the future. Her successor will be appointed by the European Council according to treaty procedures. This transition occurs against the backdrop of an ongoing interest rate hike cycle, energy shocks, and sovereign wealth disparities, with markets focused on whether the policy framework will remain consistent. The data-dependent approach and the statement of not pre-committing to a specific path reduce the impact of the leadership change on short-term decision-making. Subsequent meetings will continue to assess the stance based on the inflation outlook, underlying dynamics, and the strength of transmission, rather than relying on individual statements. During Lagarde's tenure, she experienced the pandemic, the energy shock, and a rapid decline in inflation, and her policy tools included interest rates, forward guidance, and balance sheet adjustments. The current statement maintains the existing reaction function, emphasizing the medium-term 2% target and smooth transmission. The leadership transition period will cover the two meetings in December and early February, and the market will continue to observe the extent to which data supports further adjustments, rather than pre-determining a specific path. At the institutional level, it was emphasized that it was willing to use all tools within its mandate, including transmission protection tools, to maintain policy effectiveness.