The ECB must base its decisions on the inflation outlook, not on the French bond market
Lena Dräger, Research Director of the Monetary Macroeconomics Group at the Kiel Institute for the World Economy, comments on the European Central Bank’s (ECB) expected decision to likely leave its key interest rate unchanged:
“At its meeting on October 29, 2026, the ECB is likely to leave the deposit rate—its key policy rate—at 2.50 percent. This pause is the right move, even though inflation has continued to rise. Once again, energy is the driving force, with prices up 18.9 percent from a year ago. Excluding energy and food, however, prices rose by only 2.5 percent, while services rose by 3.2 percent. According to the ECB, wages have so far barely reacted to the energy price shock. Although consumers expect inflation rates to remain elevated over the next twelve months, according to an ECB survey, expectations for the next five years have remained stable. Thus, broad-based price pressure has not materialized so far, and the recent key interest rate hikes have yet to take full effect.
At the same time, the situation in the bond markets is worsening, particularly in France. The yield on 10-year French government bonds rose on October 22 to its highest level since 2002; as early as September, France had to pay more than Italy for 10-year loans. German government bonds, by contrast, are considered a safe haven, and their yields fell in October. The reason for the rise in France is the high budget deficit and the resulting increase in public debt. The French minority government cannot secure a solid majority for its 2027 budget, amid fierce protests and uncertainty surrounding the presidential election in the spring.
To avoid a potential conflict of objectives, the ECB should emphasize that the key interest rate is guided solely by the inflation outlook. If this outlook deteriorates significantly in the new December projections, another rate hike would be appropriate—even if it further increases France’s borrowing costs. The ECB has its own tool to counter unjustified turbulence in the bond markets: the Transmission Protection Instrument (TPI). Whether the ECB could potentially use it depends, among other things, on how the European Commission assesses the French draft budget. Until then, the ECB should not signal any assistance: bond purchases before a credible budget is presented would relieve the pressure for fiscal consolidation and undermine the ECB’s independence. The situation would be different if the crisis were to spread to countries with sound budgets—protecting them is precisely the purpose of the TPI. Paris must find its own way out of the budget crisis.”
