Lagarde’s poor timing and the challenges facing whoever takes the helm at the ECB

The change at the helm of the European Central Bank could not have come at a worse time. For various reasons. First and foremost, price stability is not yet assured. European inflation rose to 4 per cent in October, up from 2.2 per cent at the start of the year. It is unlikely that the surge seen in recent months will reverse by February, when the handover will take place between Christine Lagarde and the new president, who is due to be appointed shortly. The interest rate rises implemented over the last six months will probably not be enough, nor will those to be decided at the next two meetings of the ECB’s Governing Council. Indeed, although inflation stems from the rise in energy commodity prices caused by the war with Iran, policies designed to support domestic demand are helping to prolong the impact on consumer prices. It is no coincidence that the International Monetary Fund has revised its forecast for European inflation in 2027 to 2.7 per cent, around half a percentage point higher than six months ago. There therefore remains considerable uncertainty as to the extent of the tightening measures that will still need to be implemented before inflation is brought back under control.

The second reason why this handover is extremely delicate is the tensions on international markets, which have manifested themselves in rising long-term interest rates and the spreads between them across different countries. These tensions are particularly significant in the eurozone, given that each country borrows separately, albeit in the same currency. This introduces an additional risk, which depends in part on the Central Bank’s ability and willingness to intervene in the government bond market should the instability spill over into the real economy. This risk does not exist in the United States, which explains why yields on 10-year US government bonds are more or less at the same level as those in France, despite the fact that the US deficit and public debt are significantly higher (8 per cent and 126 per cent respectively in the United States for 2026, compared with 5 per cent and 118 per cent in France).

This type of tension is not new in the eurozone. It had already emerged during the 2011–12 crisis, then in 2018 when the Italian spread rose to 300 basis points during Giuseppe Conte’s first term as Prime Minister, and again in March 2020 following the outbreak of Covid. In all those instances, the measures implemented to counter financial tensions were not at odds with the monetary policy stance. In other words, the objective of financial stability did not require measures that conflicted with price stability. In the autumn of 2011, for example, the decision to extend the maturity of banks’ refinancing operations to ease tensions was taken in tandem with a cut in interest rates. At the end of July 2012, Mario Draghi’s ‘Whatever it takes’ statement came just a few days after another rate cut. Following the outbreak of the Covid-19 pandemic in March 2020, when spreads widened further – partly due to unclear communication from the ECB – market intervention took place whilst interest rates were still negative and inflation was falling.

On the contrary, in the current situation – which is set to continue for the coming months, not least in view of the various upcoming elections – any measures taken to ensure financial stability risk conflicting with the monetary tightening required to restore price stability. This could paralyse the Central Bank’s actions, due to fears of compromising its primary objective or of appearing too lenient towards a country’s public finances. One example of this is the ECB’s decision not to suspend – as the Bank of England and the Federal Reserve have done – the policy of so-called ‘quantitative tightening’, which involves reducing the central bank’s balance sheet in response to rising long-term interest rates.

In such a context, the ability to reconcile potentially conflicting objectives depends not only on the Central Bank’s concrete actions but also on how the financial markets perceive its determination to react in an emergency. One example is the announcement, in July 2012, that the ECB was prepared to carry out unlimited interventions to safeguard the integrity of the euro: it was so credible to investors that it produced immediate effects without the ECB having to take any action. In fact, the main intervention tools adopted by the ECB to counter financial instability – such as the OMT (Outright Monetary Transactions) or the TPI (Transmission Protection Instrument) – have never been used. The mere threat of using them was enough to calm the markets.

In order to ‘manage’ expectations, the central bank needs to communicate with the financial markets in a carefully calibrated manner. This is more of an art than a science. For this reason, it is not uncommon to make communication errors, which are then difficult to rectify, especially at the start of a new term of office, as has also been seen recently in the United States.

Changing leadership at this juncture, for reasons that are, moreover, incomprehensible, is an even greater mistake.