“The Disinflation Process Is Over” – Strong Words, But What Now for the Euro?
Economists had expected the September meeting of the European Central Bank to be a non-event. The Bank had already cut rates eight times and handily achieved its 2% inflation target back in June. There was surely not much else that needed to be done other than repeat the usual lines about being “data dependent” and operating on a “meeting by meeting” basis and call it a day, right?
Lagarde Did Not Stick to the Script
Instead, Christine Lagarde dropped a line that made investors sit up: “The disinflation process is over.” Within minutes, the euro rallied, with traders taking the comment as a signal that the ECB is highly unlikely to cut rates again, despite the clear economic risks hanging over the bloc. That hawkish tilt landed just as the US Fed was setting up for a new cycle of easing, pushing the euro close to a four-year high against the dollar.
Ignoring the Elephant in the Room
The surprise was all the greater given the backdrop heading into the meeting: Debt sustainability concerns are spreading across the bloc, particularly in Lagarde’s native France after it had just ousted its fourth Prime Minister in two years during another futile attempt to rein in spending. Lagarde was nonetheless evasive when journalists dared address the elephant in the room, suggesting that there was no issue as the bond market continued to function smoothly and with good liquidity, and that in any case the topic of debt was not even discussed at the latest policy meeting. It was only when pressed that she countered that she was certain that European policymakers (without specifying which ones) knew their obligations and would adhere to the bloc’s clear rules on debt sustainability.
Markets May Take Some Convincing That Everything is Fine
In essence, Lagarde and the ECB are trying to project calm during what are still quite turbulent and uncertain times. Variations of the phrases “we are in a good place” and “things are where we want them to be” were peppered throughout the speech and subsequent responses to the press (to varying degrees of credibility). Yet, at the same time, she reiterated that the bank remains both able and willing to act, come what may. This appears to be an evolution of the usual strategic ambiguity, reassuring that everything is fine, though not so subtly reminding everyone that the bank possesses powerful tools to respond to any situation. It seems that markets may nonetheless take some convincing that this is an accurate portrayal of the situation. Indeed, since the ECB meeting France has had its debt downgraded by two separate credit ratings agencies, with its long-term bond yields now trading in excess of Greece’s as the turmoil drags on.
It Would Be Naive to Ignore Looming Economic and Political Risks
Despite the recent boost to the euro, risks to the currency nonetheless remain real, and two-sided. On the one hand, supply chain disruptions, energy market shocks, and the imminent defence spending splurge across the continent could yet keep prices elevated, justifying the Bank’s hawkish bias. On the other-hand, recent euro strength and the reduced risk of reciprocal US trade tariffs could potentially cause inflation to undershoot in the coming months, forcing the ECB to backtrack. A deeper political crisis in France could also undermine stability and shatter investors’ hopes that Europe is the new safe haven amid the chaos of Trump’s second term, reversing one of the main drivers of the euro’s recent outperformance.
What next?
In short: While the ‘disinflation is over’ declaration looks potentially premature, the ECB’s “data-driven and meeting-by-meeting” approach still gives it flexibility to react to any future challenges that may arise - and there may be many - but it also ensures the euro will remain sensitive to both domestic headlines and US policy signals in the weeks and months ahead.
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