European Central Bank keeps key interest rate at 2.5%

The European Central Bank voted to keep interest rates steady on Thursday, meeting market expectations, even as euro zone inflation rose to a three-year high.

It kept the central bank’s key rate, the deposit facility, at 2.5% after a 25 basis point increase in September.

In a statement, the institution’s Governing Council said that the rise in energy prices poses an inflationary risk and a downside risk to growth, but that underlying inflation and wages have so far been stable.

“At this point we do not see any second-round effects other than what has been included in the projections” released in September, ECB President Christine Lagarde told CNBC’s Annette Weisbach during a press conference.

Lagarde identified the main developments since the ECB’s last meeting as higher energy costs in oil, petrol, fuel, gas and refining, and an increase in long-term financing costs, with the 10-year average yield averaging around 35 basis points.

“If you combine these two factors – it’s true, the Governing Council denies that the increase is appropriate – but based on the uncertainty that has accumulated and also increased, on the basis of inflation that generally remains unchanged, the Governing Council unanimously decided that we are in a sufficient position at this stage to continue and that the measured approach remains appropriate,” Lagar.

Money markets priced in a 67% chance of a rate hike in December following the announcement, according to LSEG data.

Headline inflation in the euro area reached 3.8% last month, the highest level since September 2023. Energy price inflation reached 18.8% amid continued unrest in the Middle East.

Resurgent pressure on energy prices following the outbreak of the US-Israeli war with Iran in February saw the ECB raise rates in June for the first time since 2023.

The economy of the euro area continued to grow in the third quarter of the year, with the recovery of services since the beginning of the Middle East conflict, the Governing Council said in the explanation of the decision on Thursday.

Manufacturing, digital services and exports are driven by AI-related investment, while government spending on infrastructure and defense supports business activity. However, pressure on energy prices could weigh on consumer confidence as higher financing costs weigh on growth.

In her press conference, Lagarde said that the ECB will continue to monitor the rise in the cost of French debt and the increased fragmentation that has worried some market observers.

Lagarde noted the cost of borrowing at the end of the curve has risen significantly around the world, which he attributed to inflation expectations and interest rates as well as “debt issuance by some hyperscalers,” which he said issued long-term bonds and pushed competition.

“Predicting the ECB’s monetary policy path is becoming more challenging,” Deutsche Bank’s chief European economist, Mark Wall, said in a note on Friday.

“One of the questions is whether the two increases have been delivered and the tightening of financial conditions since September is enough to inhibit the increase in the risk of energy inflation? Probably not.”

Wall said another key question is whether Lagarde’s departure as ECB president – a decision announced earlier on Thursday – will affect next year’s decision.

“We think institutions are bigger than people, but there is uncertainty. We expect one to rise again to 2.75% in December when Lagarde is still President, and that is probably the end of the hiking cycle.”

Dean Turner, chief euro zone and UK economist at UBS Global Wealth Management, said Thursday’s decision “should be viewed as a hawkish pause rather than the end of the tightening cycle.”

France’s fiscal challenges are not expected to change the direction of monetary policy “without further financial stress,” he said in emailed comments.

“The ECB’s focus remains firmly on ensuring that current energy-driven inflation does not develop into a more persistent problem.”