European Central Bank President Christine Lagarde says the global bond-market selloff is tightening financial conditions in the euro area more sharply than the ECB expected, creating an additional drag on growth that could ultimately reduce inflation.
Long-term interest rates have risen substantially as investors confront government debt concerns, persistent inflation risks and growing competition for capital from massive artificial-intelligence investments. France has been among the European sovereign markets experiencing particularly strong pressure.
Lagarde said financing conditions have tightened since the ECB’s previous meeting and that the effect on economic growth could be greater than assumed in the central bank’s September projections.
Higher market yields increase borrowing costs for governments, businesses and households even without another central-bank rate increase.
That creates competing forces for policymakers.
Higher fuel prices associated with the Iran war are increasing inflationary pressure and squeezing household purchasing power. At the same time, rising bond yields increase financing costs, potentially weakening investment and consumption.
Lagarde said tighter financial conditions should slow growth and reduce the extent to which higher fuel prices pass through into broader inflation.
The ECB has already raised rates twice during the past four months. Another increase is expected by markets in December, which would take the policy rate to 2.75%, a level considered restrictive.
Other ECB policymakers are maintaining a cautious stance.
Bundesbank President Joachim Nagel indicated that further tightening may still be necessary, while Finland’s Olli Rehn said policymakers are monitoring whether higher energy prices spread into wages and other prices.
Rehn said there is currently no evidence of those second-round effects.
The broader issue for investors is that financial markets themselves are now performing part of the central bank’s tightening work.
If sovereign and corporate borrowing costs remain elevated, the ECB could face less pressure to raise its policy rate aggressively even if headline inflation remains uncomfortable.
Markets should now watch European sovereign yields, energy prices and incoming inflation data for evidence that tighter financial conditions are beginning to materially slow demand.
