RPT-MNI SOURCES: Bond Selloff Clouds ECB Dec Rate Call

Higher bond yields and nerves over France's fiscal trajectory mean that what was previously an almost guaranteed interest rate hike by the European Central Bank in December is now less certain, with officials judging that market financial tightening might now give them more time to assess the inflation outlook, Eurosystem sources told MNI.

“The situation isn't right for raising rates [at the ECB’s meeting on Oct 27], but looking beyond that makes little sense right now,” said one source, with other officials noting that the latest inflation data remain a concern, with consumer prices jumping an annual 3.8% in September, but that while pressures are building there are still no signs of second-round effects.

Higher yields have bought the ECB time following its 25-basis-point hikes in June and September which took the deposit rate to 2.5%, though policymakers need to remain vigilant about price pressures spreading beyond energy, another source said. Brent crude is now trading at about USD115 a barrel, up about USD45 from prices before the U.S.-Israeli attack on Iran in late February, whereas European gas contracts are 240% higher at EUR95 /MWh.

But December’s decision is now more open, sources said, stressing that the ECB should not be seen as following a mechanical path towards further tightening.

“The decision on rates?” one source said. “Even more likely to hold in October with a hike coming in December. I don't see that changing at all. But I can now see a two-sided risk developing to that, although by far the greater chance is on a hike.”

The decision will depend on incoming data and the Governing Council's analysis at the time, the source added.

“Meeting by meeting means meeting by meeting like Brexit means Brexit. Markets have a view but we also form views and if those views differ from the markets - and the day those views differ from the markets you will know it,” another source said, arguing that the Governing Council must retain the freedom to surprise markets if its assessment of the data differs from investors' expectations. (See MNI SOURCES: ECB Likely To Wait Till December Before Next Hike)

ELEPHANT IN THE ROOM

France's political and fiscal difficulties will be the elephant in the room at this week’s ECB meeting, with the topic not making it into the official agenda but potentially forming part of the wider economic and financial outlook discussion.

Sources do not expect a change in the central bank's statement, and any reference to the issue would come in ECB president Christine Lagarde answers to journalists. The ECB is likely to repeat phrasing which has featured in recent statements that its existing instruments, such as the Transmission Protection Instrument, remain available to ensure that inflation stabilises at target and to preserve the smooth functioning of monetary policy transmission

While sources acknowledged that a point could eventually be reached where market pressures spiral out of control, they stressed that there was no specific yield or spread level at which the ECB would automatically intervene or how. The official position is that the situation must be addressed by the French authorities.

“The French situation will be part of the rounded discussions, no doubt, but will be framed in the response arc of still for the French government to deal with,” one source said, with others pointing to the low incentives for the central bank to address a yield blow out clearly related to high debt levels and borrowing.

 Policymakers are aware the rise in French yields has occurred in the context of wider increase in borrowing costs, while any eventual ECB bond market response would depend on whether pricing becomes dysfunctional, rather than on a predetermined numerical threshold.

MNI SOURCES: Bond Selloff, France, Clouds ECB Dec Rate Call

Higher bond yields and nerves over France's fiscal trajectory mean that what was previously an almost guaranteed interest rate hike by the European Central Bank in December is now less certain, with officials judging that market financial tightening might now give them more time to assess the inflation outlook, Eurosystem sources told MNI.

“The situation isn't right for raising rates [at the ECB’s meeting on Oct 27], but looking beyond that makes little sense right now,” said one source, with other officials noting that the latest inflation data remain a concern, with consumer prices jumping an annual 3.8% in September, but that while pressures are building there are still no signs of second-round effects.

Higher yields have bought the ECB time following its 25-basis-point hikes in June and September which took the deposit rate to 2.5%, though policymakers need to remain vigilant about price pressures spreading beyond energy, another source said. Brent crude is now trading at about USD115 a barrel, up about USD45 from prices before the U.S.-Israeli attack on Iran in late February, whereas European gas contracts are 240% higher at EUR95 /MWh.

But December’s decision is now more open, sources said, stressing that the ECB should not be seen as following a mechanical path towards further tightening.

“The decision on rates?” one source said. “Even more likely to hold in October with a hike coming in December. I don't see that changing at all. But I can now see a two-sided risk developing to that, although by far the greater chance is on a hike.”

The decision will depend on incoming data and the Governing Council's analysis at the time, the source added.

“Meeting by meeting means meeting by meeting like Brexit means Brexit. Markets have a view but we also form views and if those views differ from the markets - and the day those views differ from the markets you will know it,” another source said, arguing that the Governing Council must retain the freedom to surprise markets if its assessment of the data differs from investors' expectations. (See MNI SOURCES: ECB Likely To Wait Till December Before Next Hike)

ELEPHANT IN THE ROOM

France's political and fiscal difficulties will be the elephant in the room at this week’s ECB meeting, with the topic not making it into the official agenda but potentially forming part of the wider economic and financial outlook discussion.

Sources do not expect a change in the central bank's statement, and any reference to the issue would come in ECB president Christine Lagarde answers to journalists. The ECB is likely to repeat phrasing which has featured in recent statements that its existing instruments, such as the Transmission Protection Instrument, remain available to ensure that inflation stabilises at target and to preserve the smooth functioning of monetary policy transmission

While sources acknowledged that a point could eventually be reached where market pressures spiral out of control, they stressed that there was no specific yield or spread level at which the ECB would automatically intervene or how. The official position is that the situation must be addressed by the French authorities.

“The French situation will be part of the rounded discussions, no doubt, but will be framed in the response arc of still for the French government to deal with,” one source said, with others pointing to the low incentives for the central bank to address a yield blow out clearly related to high debt levels and borrowing.

 Policymakers are aware the rise in French yields has occurred in the context of wider increase in borrowing costs, while any eventual ECB bond market response would depend on whether pricing becomes dysfunctional, rather than on a predetermined numerical threshold.

MNI INTERVIEW2: PBOC Needs To Aim At 2% Inflation Target

China’s central bank needs to further lower policy rates while committing to a 2% inflation target, in order to drive down real interest rates, reverse low price expectations, and counter weak domestic demand, a prominent policy advisor told MNI in an interview.

Amid the current shortfall in domestic demand, the primary objective of monetary policy should be lowering real interest rates to stimulate private sector investment, which requires both reducing financing costs and lifting inflation expectations, said Zhang Bin, deputy director at Institute of World Economics and Politics at the Chinese Academy of Social Sciences.

The recent pickup in producer price inflation is largely tied to energy and upstream supply chains, such as for integrated circuits and semiconductors, but consumer price inflation remains subdued at around 1%, a situation likely to persist without additional policy support, he said, adding that the low rate of increase in prices is also depressing expected returns for household home purchases and on corporate capital expenditure.

"To generate endogenous growth momentum, a decline in real interest rates cannot be avoided," Zhang said. The People’s Bank of China must make a firmer commitment to a future inflation path and strive to hit the 2% inflation target if it is to guide price signals and expectations more conducive to corporate investment and home purchases, he said. (See MNI INTERVIEW2: China Needs Monetary Easing To Boost Growth)

His comments come as other advisors and economists have told MNI that the PBOC is likely to hold its policy rate unchanged over the rest of the year, though it could still reduce banks’ reserve requirements, amid concerns that any broad easing could undermine the drive towards economic restructuring and boost bubbles in areas like AI. (See MNI: PBOC Seen Holding Rates, But Reserve Ratio Cut Possible)

YUAN

Nominal rate cuts must outpace the drop in inflation expectations to stimulate private sector spending, said Zhang, pointing to the property sector as an example. If people anticipate that rents will stagnate, few will buy real estate, he noted.

Weak domestic demand has also weighed on the pace of yuan appreciation. From 2005 to 2019, the yuan appreciated by an average of 3% annually, but in recent years, neither the yuan nor its real effective exchange rate has shown substantial appreciation, while nominal effective exchange rate gains have also been modest, Zhang said, noting that market participants are reluctant to hold yuan-denominated assets in an environment of deficient domestic demand and depressed corporate profitability.

"If China emerges from weak domestic demand and the yuan returns to its historic track, the currency could appreciate at an annual rate of 3%,” he said.

More than 85% of the slowdown in consumption growth can be traced to sluggish nominal GDP growth, which has slowed growth disposable income, Zhang mentioned

For several years, the nominal GDP deflator has lingered around -1%. Under a reasonable level of aggregate demand, the deflator would rebound from -1% to 2%, adding three percentage points to nominal GDP growth. If prices were to rise by three percentage points and real output were to expand by 1.5 percentage points, nominal GDP growth could accelerate by 4.5 percentage points, Zhang said. 

Addressing concerns that rate cuts would further compress commercial banks' net interest margins, he pointed out that lower interest rates could help lenders improve asset quality and reduce non-performing loan ratios.

MNI INTERVIEW: China Advisor Calls For More Public Investment

China needs to expand public investment in order to boost consumption and support employment, a prominent policy advisor said, arguing that broad fiscal spending should grow faster than the economy-wide average if the country is to break free from a negative spiral of contracting expenditure.

Calls for China to rebalance its economy often focus on moves to boost consumption, enhance social welfare, and assist lower-income groups, but these steps alone are not enough to resolve the broader shortfall in aggregate demand, said Zhang Bin, deputy director at Institute of World Economics and Politics at the Chinese Academy of Social Sciences.

While China’s export- and AI-related sectors remain buoyant, negative growth in broad fiscal spending has been a major drag, intensifying downward pressure on demand in the second and third quarters, Zhang noted, warning of a self-reinforcing cycle in the absence of decisive intervention by the government.

Investment was long the cornerstone of the economy, but manufacturing, real estate, and infrastructure investment are all experiencing downward pressure, he said.

"Expanding domestic demand not only bears on employment expectations, but also affects income distribution and external relations,” he said, referring to international discomfort over China’s reliance on exports.

Broad fiscal spending growth must outpace average economy-wide expenditure to achieve a genuine counter-cyclical effect, whereas from 2022 to 2025, broad fiscal spending lagged economy-wide spending growth by an average of 1.8 percentage points, Zhang said in an interview.

“Over the past two years, shifts in the pace of fiscal spending have been the primary driver of China's economic fluctuations,” he said.

To support demand, a nominal output gap estimated at around CNY6.3 trillion must be addressed, he said, noting that if this gap were to be filled entirely through consumption, consumption would need to grow by an additional 11.3%, versus actual growth of  retail sales of only 1.1% y/y in the first nine months of 2026. （See MNI INTERVIEW 2: China's Econ Restructure Needs More Support）

Substantial public investment could swiftly repair corporate and household balance sheets, bolstering earnings and household incomes, Zhang noted.

"Consumption and investment are never zero-sum trade-offs, and investment leads consumption,” he said. “If forced to choose, public investment is both more urgent and more critical in expanding domestic demand in the short term.”

Zhang still sees massive room for public investment, including the "six networks," particularly data centres and underground utility tunnels. More than 100 million migrant workers are unable to settle in cities for lack of housing, public infrastructure, and supporting amenities, while a vast array of existing assets also requires regular maintenance and renewal, he added, mentioning that these activities account for 70% to 80% of total investment in developed economies.

FISCAL SPENDING

Broad fiscal spending, including general public budget and government-managed funds, trended downward for 13 consecutive months from July 2025 to September 2026, the second-longest contractionary streak in the past decade, trailing only the March 2022 to July 2023 period when local government debt oversight was tightened, Ministry of Finance data shows.

The MOF disclosed last week that general public budget expenditure rose 1.0% y/y in the first nine months of this year to about CNY21.0 trillion, well below the 4.4% growth targeted in the 2026 budget. Zhang noted that broad fiscal spending fell 3.5% y/y in the period, adding that had fiscal expenditure kept pace with average economy-wide spending growth, it would have finished Q3 about CNY1.6 trillion higher. (See MNI: Advisors See New Bond Quotas To Bolster China Growth)

EMPLOYMENT

China’s labour market remains under pressure, Zhang said, pointing to PMI employment sub-indices showing contractions in construction and consumer services.

Even though capital-intensive, high-tech AI investment generates less employment than traditional public works, public investment projects can still deliver immediate and tangible job gains, he said.

The surveyed urban unemployment rate for the 16–24 age group, excluding students, stood at 18.0% in September 2026, compared with the headline national urban rate of 5.2%, according to the NBS.

China can tolerate a moderate slowdown in headline GDP growth whilst it restructures its economy, but achieving full employment remains non-negotiable, Zhang said. Next year’s GDP growth target is likely to be set around 4.5%, he said.

MNI POLICY: Early Signs Higher Rates Hitting Japanese Capex

Reports by Bank of Japan branch managers that some smaller firms are already postponing capital investment plans under the impact of tighter monetary policy are adding to officials’ concerns about how much further they can raise the policy rate, MNI understands.

September’s 25-basis-point hike to 1.25%, combined with economic uncertainty, has already had an impact on smaller firms, according to the quarterly branch managers’ meeting, which also pointed to the effect on real estate firms. Officials think the accumulated impact of past hikes could emerge quite suddenly,  dampening inflation and output, though they see the risk of a sharp downturn as small.

These concerns have emerged as the BOJ weighs whether the additional 25bp hike widely expected for December might be better postponed until January’s meeting, unless upside risks to prices strengthen. A decision to hold off the increase until the new year could imply that the tightening cycle would be more likely to be capped at 1.75% rather than 2%.

DECEMBER TANKAN

The direction of corporate inflation expectations in the December Tankan survey will be another key factor in the decision over whether another hike is coming this year, with particular attention given to the inflation views for three and five years ahead. (See MNI POLICY: Corp Expectations Data Key For Dec BOJ Decision)

For the moment, short-term rates remain negative in real terms, mitigating the effects of tightening so far, but bank officials are monitoring companies’ “hurdle rates”, the minimum rate of return they must earn on an investment to justify the risk and cost of capital and how this compares to funding costs.

Firms’ judgements as to the extent to which they are still able to raise prices to compensate for higher funding costs is also key.

Reports so far of postponed investments also have to be further analysed for their significance, with more information to be gleaned from the December Tankan survey results on firms’ financial positions and lending by financial institutions.

Officials at the BOJ’s headquarters are asking bank branches to gather evolving business plans on a real-time basis.

MNI INTERVIEW: Fed Will Hike Later To Keep Up With AI- English

The Federal Reserve will continue to tighten monetary policy in due time, in part because AI-related spending is raising the neutral rate of interest, the former director of the Fed Board's division of monetary affairs William English told MNI.

The Fed will likely leave interest rates in a 3.75% to 4% range this week, English said, while Chairman Kevin Warsh will be asked to explain the pause amid elevated inflation. English expects a rate hike at the FOMC's December meeting and early next year. 

"Monetary policy a little tighter along the way, but not a lot," he said. "That'll be enough to keep output near potential, keep employment near the natural rate, and inflation will gradually come down because expectations have stayed pretty well-anchored out a few years and so that will pull inflation down to those expectations."

That "may take a couple of years but I think we get there," he added about inflation. 

HIGHER NEUTRAL

RISKS 

Still, there are numerous risks to the medium-term outlook. There is the threat of a longer-lasting conflict with Iran that could pressure energy costs and inflation. But there is also the chance that a continuing Middle East conflict could cause consumers to pull back spending and save more amid the uncertainty, said English, now at Yale University. 

MNI FED WATCH: October Hold With More Hikes Expected

The Federal Reserve is set to hold interest rates steady Wednesday after officials signaled they are not in a rush to tighten and will wait to see whether demand softens in the face of rising costs and supply-side pressures ease. 

Economic activity has strengthened in recent months, providing the FOMC with a flexible buffer to evaluate incoming data and confirm whether price growth is accelerating before taking further action. Tightening among other major central banks should also create some spillover to U.S. financial conditions, helping to tame domestic price pressures. (See MNI POLICY: Fed In No Hurry But Committed To Taming Inflation)

Fed Chairman Kevin Warsh said Oct. 16 just ahead of the communications quiet period that the economy had "broadly conformed" to expectations since September.

A hold decision could draw dissents from regional Fed presidents who have argued for quicker adjustments. The Middle East conflict continues to put pressure on inflation, and the AI build-out is keeping the economy operating close to capacity. The Fed's preferred inflation gauge is expected to have accelerated a tenth to 3.7% in October, with core PCE inflation steady at 3.1%, according to the Cleveland Fed's nowcast. (See MNI INTERVIEW: Services Prices Show No Sign of Slowing - ISM)

Former Fed officials expect the Fed to resume tightening in December and again in the first quarter of next year, and markets are fully priced for at least two more hikes by spring. (See MNI INTERVIEW: Lockhart Sees Next Fed Hikes in Dec, Q1)

AI BOOM

The AI investment boom has unexpectedly emerged as the predominant inflation risk for the Fed by fueling massive demand for resources that could last years before productivity gains expand supply. (See MNI POLICY: AI Buildout Emerges As Top Inflation Risk For Fed)

Taylor rules would call for a fed funds rate of 4.5-5% to make monetary policy restrictive enough to bring down inflation, former Richmond Fed President Jeffrey Lacker told MNI. (See MNI INTERVIEW: Fed Rate Must Near 5% To Tame Inflation-Lacker)

That’s partly because rapid economic growth and strong investment demand are lifting the neutral rate of interest, making current monetary policy relatively more accommodative and forcing the Fed to raise rates simply to maintain a restrictive stance.

If markets begin expecting a permanently higher rate of productivity growth from AI, the longer-run neutral rate also rises. The Fed would then need to hold rates higher over the long term rather than rely on productivity as a disinflationary tailwind.

FRAMEWORK CHANGES

Meanwhile, Warsh continues to lay the groundwork for regime change at the central bank, though the most profound shifts are months away and unlikely to shape the current course of monetary policy. 

His external task force on productivity will conduct a field hearing in California next month. 

A foundational reassessment of the inflation framework and the optimal policy implementation framework, based on recommendations from two other task forces, will be thoroughly debated next year, and any changes would be implemented only once inflation is back near target and the Fed's portfolio contains a larger share of Treasury bills. (See MNI POLICY: Warsh Regime Change Strategy Starts To Reshape Fed)