Interest rates hold, inflation soars, and Christine Lagarde departs.
A flurry of recent news from the European Union has put the eurozone economy into the spotlight: amid a background of solid growth in the manufacturing Purchasing Managers’ Index (PMI), the European Central Bank (ECB) has held off another rise in interest rates as inflation sticks at 3.8%, almost double its medium-term target of 2%. On top of this, the president of the ECB, Christine Lagarde, has announced her intention to resign in February 2027, roughly nine months earlier than her tenure is expected to end.
There is, evidently, a lot going on in this, but despite the significance of Lagarde’s announcement, the most important is the level of inflation. With the current level of inflation at 3.8%, reached in September, it’s the highest rate that the eurozone has seen in three years, having jumped from 3.2% in August, and 2.9% in July. And the rate of inflation is only continuing to accelerate, fed primarily by energy inflation rising from 14.3% in August to 18.8% in September alone, and responsible for about half of the headline inflation rate. Core inflation, however, edged up marginally from 2.4% to 2.5%, meaning that second-round effects are limited at the moment.
There are, moreover, no signs of slowing down: the Irish Times even predicts that eurozone inflation might reach 4%, while the Italian economy saw its own flash inflation reach 5.4%, with energy up to 31.4%. Headline inflation in September followed a similar trend across the eurozone, with Spain at 5%, Italy 4.1%, France 3.4%, and Germany 3.3%.
A major driver of the inflation is the steady growth in PMI, which reported a rise to 52.9 in September 2026: rising from 52.7, the third rise in a row, and the highest since May 2022. New orders grew at their fastest rate since early 2022, with export growth at a four-and-a-half year high, while output hit a 55-month high of 53.6, and business confidence was reported to be its strongest since February.
The lead has largely come from capital goods, with S&P Global’s Chris Williamson putting this down to investment in AI and defense-related equipment. The growth itself was broad-based, led by the Netherlands at 55.6, closely followed by Germany (53.8), France (50.3), Italy (50.4), and Spain (51.0).
However, while the eurozone economy may be buoyed by mass investment in both future-facing technologies in the form of AI and playing catch-up after decades of lagged investment in defense, on the ground the signs are less positive. Consumer goods demand keeps falling, especially as households face cost of living increases.
Hence the need to pay closer attention to inflation, and the ECB’s decision, reached on October 29, not to raise rates for a third time in 2026—at least, not yet. In the press conference following the decision, Lagarde and Vice President Boris Vujčić note that energy price rises “have hit consumer confidence” alongside a level of unemployment at 6.4%—that remains stubbornly high (now at 6.5%) despite the aforementioned resilience in the PMI.
Will the ECB raise rates again before the end of the year? The hawks on the Governing Council argue that the delayed impacts of energy prices, especially gas costs, will lead to core prices rising faster than before. If it’s a data-dependent approach to whether rates should rise, they argue, then the data is only pointing one way.
The case for patience and waiting to move points to a separate but equally valuable set of data. The labor market is relatively soft, which limits what workers can expect or demand, and the rise in long-term borrowing costs is doing some of the ECB’s tightening for it. Capital Economics predicts that the ECB will wait at least until December to make a decision; investors, on the other hand, are pricing up to three more rate rises over the next fiscal year.
Moreover, those who argue for restraint have historical precedent on their side. In 2011, the ECB raised rates in April (from 1% to 1.25%) and again in July (up to 1.5%), only three months later, against an inflation its own president at the time attributed mostly to energy and commodity prices. It was the first rise in rates since the credit crisis began in 2008; by November, with the sovereign debt market in crisis, rates were being cut once again. The two circumstances are not identical—and a rate of inflation at 3.8% is not one that can be easily ignored—but the lesson of 2011 is a reminder that rate rises cannot lower the price of gas, only the demand of those who buy it.
While the press conference pinned its hopes on “a recovery in confidence and real incomes, driven by gradually declining energy prices and a robust labour market” that “should bolster domestic demand,” the October numbers temper this hope: private sector growth slowed in October to its weakest pace in four months, while national economic growth in Q3 has been sclerotic, to say the least. While the eurozone average was 0.4%, Germany’s GDP growth was 0.2%, Italy’s was flat, and France’s was −0.1%. France is facing its own economic problems, including a possible sovereign debt crisis, and it is the economic and political circumstances in France that are feeding Lagarde’s decision to step down as president.
Lagarde, whose tenure spanned some of the most significant moments in Europe’s 21st century—from the pandemic, to the energy crisis, the invasion of Ukraine, and the eurozone’s biggest inflation shock—is herself a political animal, not an economist. Having previously been France’s finance minister, and head of the IMF, Lagarde has always approached the job in the way a politician would. Indeed, a survey in 2024 of the ECB’s own staff showed that there was a perception “among staff that Lagarde was too focused on matters unrelated to monetary policy.”
In Lagarde’s own statement on her decision to step down, she indicated that she is looking for “greater freedom to express her views and to engage in non-monetary matters, because she cannot remain neutral when she sees the developments taking place in her own country and in the world.” While political neutrality is part of the reason for Lagarde’s resignation, the timing is specifically due to the developments Lagarde is pointing to: Reuters has suggested that, by stepping down before the end of February, she is “giving current European Union leaders time to pick her successor before a French presidential election that polls show far-right candidate Marine Le Pen is favoured to win.”
Whether Lagarde’s replacement will be the former Bank of Spain governor Pablo Hernández de Cos, or the Dutch candidate Klaas Knot, or even the outsider option Joachim Nagel, current chief of Germany’s Bundesbank, the harder question is institutional: Will a third rate rise come in December?
