ECB Holds Steady as Lagarde Heads for the Exit

The European Central Bank (ECB) held rates steady today, just a day after the Federal Reserve (Fed) did the same. But the bigger news may be that ECB President Christine Lagarde announced she will step down in February, well before her term is set to end in October 2027.

Key takeaways

The ECB is pausing, not pivoting. While energy prices have continued to rise, core inflation has remained relatively stable. In addition, financing conditions have already tightened materially, helped by two ECB hikes this year. The central bank stressed its commitment to a data-dependent, meeting-by-meeting approach in this environment of heightened uncertainty and inflation risks.

Core inflation is the data to watch. As with Federal Reserve Chair Kevin Warsh, Lagarde is looking for more data before the ECB’s next meeting, but she was more specific about which data matter most. She suggested that core inflation in the next two inflation prints will be the most important release between now and the next  meeting, because it will show whether energy inflation is seeping into core inflation.

The bond-buying backstop is in the toolbox, but France is on its own for now. French government bond yields have risen significantly on concerns about fiscal sustainability, which has made many wonder whether the ECB would use its Transmission Protection Instrument (TPI) to buy French bonds and bring down yields. The ECB noted in its statement that the TPI, an emergency bond-buying program, “remains available to counter unwarranted, disorderly market dynamics.” However, the ECB seems very reluctant to use it right now because it believes the problem facing France is self-created. At the press conference, Lagarde said, “fiscal sustainability is the anchor for broader economic stability,” which is in sync with other recent statements she made at a separate industry press event earlier this month: “The primary and first solution lies at home in France. And it has to do with fiscal policies.” In other words, the TPI is there if the ECB needs it, but it doesn’t believe it should be used to help France, at least not now.

Lagarde’s early exit looks tied to French politics, in my view. Her early departure had already been telegraphed, and the catalyst seems to be the French presidential elections in April 2027, which could result in the election of far-right candidate Marine Le Pen. Resigning early allows EU leaders to choose the next ECB president before a new French president is elected. The ECB president goes through a lengthy selection process but is ultimately appointed by the European Council; the candidate must garner 16 of 21 votes, and those votes must represent at least 65% of the euro area population. As the second-most populous country in the EU, France’s vote will be important.

Lagarde isn’t the only seat to fill. Other ECB members will also need to be replaced. For example, Germany’s Isabel Schnabel recently announced her resignation as well.

Market reaction, looking ahead

European stocks rose today, largely driven by strong earnings but certainly helped by the ECB keeping rates on hold, while the 10-year French bond yield eased slightly. Looking ahead, I think a December rate hike remains a very real option and will be largely dictated by upcoming core inflation data.

We should follow developments closely to see if we get to the point where the ECB is ready and willing to use the TPI. I think that is very unlikely. I think it is more likely that we could see a targeted slowdown of quantitative tightening (QT) to support French bonds, although I expect the ECB will be reluctant to even do that.

Significant attention going forward will likely be focused on the choice of Lagarde’s successor. At this juncture, the early frontrunners seem to be Klaas Knot, former governor of the Dutch central bank, and Pablo Hernández de Cos, former governor of Spain’s central bank and general manager of the Bank for International Settlements. Both, in my view, are considered to be very competent and experienced central bankers.