Jacob Funk Kirkegaard brings a wide lens and deep knowledge base to the question of what’s driving the European Central Bank now as it hikes its key rate for the second time this year while rising energy prices boost bets on yet another rate hike by year’s end.
For starters Jacob is a prominent economist affiliated the Peterson Institute for International Economics (PIIE) since 2002, and since 2024 also with Bruegl in Brussels.
And before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector.
He says the ECB’s rate hike is all about rising oil and gas prices. “I think the ECB will… probably have looked at the headlines as they were contemplating <their monetary policy decision> today and seeing that, Well, prices sure went up a lot today didn't they?”
And Jacob agrees that the energy price rise is the reason why the rate move was so widely expected and why no one opposed it. “Christine Lagarde obviously said that it was a unanimous decision which…unfortunately, given the circumstances, makes perfect sense.”
He sees the ECB getting worried that the recent rise in headline inflation above 3% , if allowed to continue unabated, could lead next to rising inflation expectations. “And the Governing Council and President Lagarde said today that it is likely to remain elevated for a prolonged period. And that’s why they hiked.”
As the ECB mildly upgrades its growth forecast, Jacob describes the European economy as surprisingly resilient in the face of energy shocks and geopolitical uncertainty. And while economic growth is not robust, he says at the end of the year if it “still clicks at about 1% growth that’s not bad, it’s not great.”
Bringing in the political dimension, he says the ECB’s hawkish stance is partly motivated by a desire to avoid the political fallout from persistent inflation, “They do not want to risk some sort of return of persistent inflation in the Euro-Area, because it’s going to put populists, Marine Le Pen into power.”
So does Jacob expect the ECB to hike rates again this year? As he puts it, “if you look at market expectations for the short end, they are expecting, you know, pricing in a number of additional hikes. I have to say personally, I’m a little I’m not there yet.”
”I think the December meeting is very open. But more than that, the war in Iran and I mean basically you’d have to have a very cold winter in Europe. The war in Iran will have to… keep being as bad as it is now. And I think a couple of other things need to happen, which I am not so sure about.”
“The first one is, as I said, you’re going to have a cold winter, so you’ve got to have further price increases in natural gas. I am a little skeptical about that because unlike in 2022, 2023, where there was a real bottleneck in the European natural gas and LNG market because there simply were not enough facilities to bring in LNG, that doesn’t exist anymore.”
On the other hand Europe is now heading into the winter heating season with a very uneven level of natural gas storage centered in Germany and the Netherlands, where storage levels are well below 50%,” he says. "It really means … if you have in Europe, a very early and unusually cold winter, demand goes up, storage facilities are low, you may get further increases in natural gas prices, and that’s clearly what is worried about. There is real weather risk out there.”
And an addded bonus: dive in and also hear who Jacob thinks will replace Christine Lagarde when she steps down as ECB president later this year and get an-depth look at the history and likely outcome of this important transition.
Spoiler alert: he thinks Lagarde will not step down early as many have predicted and that her successor will be either Klaas Knot, former president of the Central Bank of the Netherlands or Pablo Hernandez do Cos, general manager at the Bank for International Settlements. Find out why.
ECB hikes rates on unanimous vote 00:00:47:09
I think the ECB will be they will probably have looked at the headlines as they were contemplating today and seeing that. Well, prices sure went up a lot today didn’t they. In the mind of somebody. I mean, Christine Lagarde obviously said that it was a unanimous decision, which I think, you know, unfortunately, given the circumstances make perfect sense.
ECB pre-war shock was in a truly good place- 00:01:37:07
What I mean, you know, everything is relative, right? I think relative to the inflation shock that Europe lived through in 2022, 2023, immediately after the Russian invasion of Ukraine. This is not nothing, but it’s not a real crisis either. What we’re looking at is, yes, the ECB, as you will recall, at the beginning of the year before the war in Iran began, the ECB has repeatedly said it was in a good place, which it was, because in headline inflation, core inflation, everything was back to target and invasion expectations were well anchored.
ECB did what they had to do- 00:02:18:23
Now we’re in a situation where I think it’s still the case that inflation expectation among European consumers and businesses remain well anchored. But obviously, as you mentioned, we have a headline is now over 3%. And the governing council and President Lagarde said today that is likely to remain elevated for a prolonged period. And that’s why they hiked. And I think I think unfortunately, they really didn’t have any choice.
Forecasts are lifted: more growth and inflation 00:02:54:24
Just on the economics, and especially because they also updated their macro forecast, this here for this meeting, they do that every quarter. Not only, of course, did they update the expected inflation number for 2027, but more importantly, they actually also mildly upgraded the growth forecast. So you have a kind of a combination of a still very resilient labor market.
Everything lined up to support a rate hike 00:03:27:18
Unemployment is near historical lows still and a Euro Area economy that everything else has actually been more resilient than I think many had feared. Despite the energy price uncertainty. So you add that up with, you know, a headline inflation number well above that target. Yeah, they’ve got to hike, they got a resilient economy, low unemployment and high inflation.
Climate and war keep food costs uncertain 00:04:46:05
One of the things that the ECB is also very worried about, because this category really was very elevated after 2022, 2023 for a long time. That is food. And we obviously on top of whatever regional stuff happens in the in the euro area. Global food prices are volatile because of the grain supply situation in the Black Sea, El Nino, all sorts of things going on with climate change.
Food prices pressure and second order wage effects are absent 00:05:17:12
But there is really no trace of food inflation at the current moment for the ECB, for in the euro area inflation numbers. Similarly, the other one that the ECB naturally pays a lot of attention to is wages. And by the ECB own wage negotiated wage, sort of projected negotiated wage data, it doesn’t look like there are any second order effects. But, so far, it really remains an overwhelmingly energy issue.
Oil price boost has become an issue 00:06:29:12
No I mean I would have said before the latest increase in oil prices literally in the last five or seven days, I would have said my base case, weak base case, would have been that two and a half is the terminal rate. But I certainly think now that oil prices again are above $100/barrel for Brent, which is the benchmark that the ECB pays attention to.
LNG price are scary strong already 00:06:59:17
But more importantly, perhaps, is the increasing price spike also in natural gas is what we have seen with European benchmark for LNG is that it has actually moved close to $80 in recent days, mildly even above that. And that is a very significant increase and well above even the ECB’s own updated forecast for natural gas prices for 2026, which in the updated macro forecast is €51 per megawatt. So we’re actually, you know, more than 50% above that already today. And we can debate why oil prices have been so relatively benign. There’s clearly less or less oil demand from China. There’s a lot of, you know, US Navy sanctioned smuggling or whatever we choose to call this sort of transponder less transits.
Little LNG out thru the strait because tankers are too expensive 00:08:17:09
The issue on the LNG market is actually somewhat less optimistic or less benign from the ECB point of view, because there’s surely a lot of oil tankers being smuggled through the Strait of Hormuz, but there’s definitely not any of the LNG tankers because they are much too expensive. It’s much too high risk. So and then on top of that, there is clearly some European natural gas buyers that have basically taken a chance.
Buyers are rolling the dice on price 00:08:55:1
Buyers in Germany and the Netherlands have basically bet. That prices would come. Down okay.
Europe’s heating supplies are at risk 00:09:02:16
So Europe is now heading into the season, the winter heating season, with a very uneven level of natural gas storage centered in Germany and the Netherlands, where storage levels are well below 50%. And what it really means is that if you have in Europe, a very early and unusually cold winter and demand goes up, storage facilities are low.
Real risk 00:09:43:09
You may get further increases in natural gas prices, and that’s clearly what there is worried about. There is real weather risk out there.
Hike expected but US fiscal position is worse than for Europe 00:10:06:13
Yeah, I mean, I think in that regard I guess it’s a little bit of a perfect storm. Obviously, as you mentioned at the beginning, this was a widely anticipated hike. It was all priced in. But what you have seen in Europe is that, you know, long term bond yields for the big European sovereigns have gone up more than in the United States, which, you know, which is somewhat surprising if you just looked at economic fundamentals, because there’s only one fiscal basket case in Europe that resembles the fiscal basket of the United Staes - namely France.
Market pricing in Multiple hikes 00:10:48:24
And what that might suggest is that and I think this is also true, if you look at market expectations for the short end, they are expecting, you know, pricing in a number of additional hikes. I have to say personally, I’m a little I’m not there yet.
Conditions for more rate hikes may not develop 00:11:13:06
I am not (locked into rate hikes). I think the December meeting is very open. But more than that, I the war in Iran and I mean basically you’d have to have a very cold winter in Europe. The war in Iran will have to, you know, keep being as bad as it is now. And I think a couple of other things need to happen, which I am not so sure about.
Some price skepticism on LNG… 00:11:39:12
The first one is, as I said, you’re going to have a cold winter, so you’ve got to have further price increases in natural gas. I am a little skeptical about that because unlike in 2022, 2023, where there was a real bottleneck in the European natural gas and LNG market because there simply was not enough facilities to bring in LNG, that doesn’t exist anymore. And there are plenty of access points. And what that means is that Europe, you know, basically had to go out on the global LNG market and buy more LNG, basically from the United States, from Australia, from, you know, even from Russia, where it is still allowed until the end of the year. So what that means is that where prices are now, where, as I said, the spot price is about 80 euros, just around €80 per megawatt. That is probably a level, or at least historically, has been a level where low income countries that are also LNG buyers are simply priced out of the market. Pakistan. Bangladesh.
Lower income countries will suffer the LNG shortage not Europe 00:13:01:18
So what that means is that at these prices, basically you don’t need to have I believe I could be wrong, but I believe I don’t think prices need in Europe to rise very much for Europe to basically hijack LNG shipments that otherwise would have gone to lower income countries. What it means is that where given where LNG prices are in Europe, you’re going to have demand destruction somewhere else because they won’t be able to get gas.
But energy price increases could spread with ill effect 00:13:35:14
Do, you know, shift fuel shift to coal or other things. But my point is that for Europe to attract adequate LNG, prices, in my opinion, don’t need to rise much more. So, I’m there for not persuaded about the case for additional price hikes. But this is an open debate, okay. Thing that needs to happen for energy price hikes to warrant further rate hikes beyond December, in my opinion, is you’ve got to have a significant spillover into electricity prices.
Situation is changed from 2022 and 2023 00:14:18:21
That was a big problem in 2022, 2023 because gas was much higher. There were a lot less nuclear facility, nuclear production because of maintenance post-Covid in France, a drought, so less hydro. You’ve had a little bit of that in the last month or so, where because of the very, very hot summer in Europe, you’ve had shutdowns of some of the nuclear production along the rivers because there’s cooling water, it, etc. but still, it’s now the fall temperatures will <adjust>.The rain will come back and there will be water in the bloody rivers, if I may put it that <way>.
For EMU 1% growth is not that bad 00:15:43:20
Yeah. I mean, I think, you know, we have to remember that the potential growth rate in the euro area is probably 1.2%, 1.3%. So if it comes in for the year 2026, having gone through a major energy price shock, again, all the uncertainty associated with that and still clicks at about 1% growth. That’s not bad. It’s not great.
Euro area conomy is not running flat out 00:16:14:02
But you know, unlike the United States, the EU is not firing on all fiscal cylinders, right? The aggregate fiscal deficit in the Euro-Area is, you know, significantly below half of that of the United States. You do not have, obviously, the AI CapEx growth that you have in the United States. So overall, 1% is you know, I as I said, the EU just upgraded by its forecast by a decimal point.
A good Eco-performance given all the realities 00:16:50:09
It’s not bad. And would I go as far as to call it a Goldilocks economy in the sense that given that you already have an energy price shock, do you want to have a risk of broader, just basic demand driven inflation? No, I don’t think the ECB would like that. And that’s one of the reasons why they are hiking.
Political back drop is shifting 00:17:17:01
You know, because they actually have a fairly resilient economy. As I said earlier, they’re not afraid of the downside. And in fact, and I think this is another quite important political economy consideration, which is that, you know, we just had a regional election in Germany, in East Germany, the far right, if they obviously did extremely well, there’s going to be a couple of other regional elections in Germany, in East Germany, where somewhat similar results should be expected.
2027 is the Big Enchilada for elections in Europe 00:17:49:22
But the big one, the really big election action, is next year in 2027, where you’ve got national elections, presidential elections, parliamentary elections in France, Italy, Spain and Poland. Basically four out of the five large EU economies. If you were if you are a central bank president who just happens to be also a former French finance minister, and you look at the, if you like, recent history of the political potency of cost of living and inflation concerns, that basically voters everywhere are really pissed about inflation.
Objective is to stop inflation now by those in power 00:18:38:07
Are you going to take a chance on inflation? I mean, does it would you rather overshoot a little on the inflation or, you know, go go down to half a percent growth? I think, frankly, that the majority of the governing Council would. That’s why they’re hawkish. They are not obviously going to say that. But this is part of why they are hawkish. They do not want to risk some sort of return of persistent inflation in the Euro area, because it’s going to put populists, Marine Le Pen into power. This is this is why it is now my base case, even though as I said, I’m skeptical about the further natural gas and even electricity price increases from where we are today.
A tilt to hawkishness? 00:20:08:19
But when I look at the political calendar and I factor in the very well understood political risks from, you know, rising prices, particularly rising fuel prices, this is one reason why the ECB, as I think might very well tilt hawkish in December. And the good news for them is they could obviously never say oh we’re doing this because we’re worried about the election next elections next year. No what they say is well things may go worse in the in the Gulf there’s upside risk to inflation and it’s all Donald Trump’s fault. And that’s why it’s a perfectly politically safe argument for potentially hiking again in December.
ECB Succession- German is OUT! 00:21:27:22
To two immediate things. You are…a German. There is, in my opinion, de facto zero chance that a German can become president of the ECB, while a German is also the president of the European Commission… That’s the first thing I would say.
No early exit 00:21:57:19
Secondly, I am skeptical that Christine Lagarde will actually leave office early. And part of it, you know, there’s all these rumors, all she’s going to the World Economic Forum and I mean, all these types of things. I am very skeptical. She’s just…publishing her memoirs. We’ve just learned in the last week or so. Well, if you already published your memoirs, are you going to take another big job?
Early selection to close Pen out?? No 00:22:35:03
And the argument that the European leaders need to select the next president of the ECB before the French elections, because otherwise maybe Marine Le Pen gets to have a vote. I don’t really buy that. If this was really a concern, they could just meet and they will meet in March, which is the final European Council meeting that Emmanuel Macron will attend.
ECB Churn… 00:23:10:18
And the other piece of news that we’ve heard on this is this, I would say, fairly well sourced rumor that is a version of the German member of the executive board is going she’s going to leave early to be to take over the market division at the IMF. Now, if that happens and rumors is that that happens by the end of the year. Then, because next year. Not only is it the chief economist, the Irish chief economist, whose name right now… Philip Lane. Yes. Philipp Lane leaves in May. Lagarde leaves in October. And her Term leaves runs out in Dec So, this is essentially a package because you have the French and the German representative leaving. So, you’ve got to have another French, a German elected. And I don’t think the Irish are going to get another seat on the executive board. But the point is that if one of them leaves early and it doesn’t have to be like. It has to be decided together. So, if Isabelle Schnabel gets the job at the IMF… and says she’s going to leave in November or December, then, or at least before her term expires, then the European leaders are going to have to make a decision on this well before the French presidential elections. I suspect they will do that, but then we will know who the next president is.
Succession! 00:25:02:19
And I believe you’re well before the president. So Christine Lagarde doesn’t need to retire, retire early. I think that’s in many ways the most likely outcome actually at this point. So that means then the final part of your question, who will. Should say full disclosure here, Klaas Knot is a colleague of mine. He’s a nonresident also at the Peterson Institute. And Pablo, the course was before he went to the BIS a colleague of mine at Bruegel where he was a visiting fellow. So, I know both of them very well.. So in that sense I’m unbiased.
Similar on Policy 00:25:48:20
The point here is that in terms of monetary policy, I think they are actually quite similar. Klaas Knot is nowhere near as hawkish as he was when he was a young Dutch central bank governor. He’s much more centrist today. No, no, no, I don’t dispute that. But he’s not he’s not that person quite I would argue the say. Not I would say he’s a continuity centrist, data dependent central bank. And I would actually argue that Pablo Hernandez de Cos is exactly the same.
De Cos from Bank of Spain 00:26:38:18
He obviously came from Spain or, you know, was the governor of the Bank of Spain and which is the central bank that traditionally, historically was, you know, on the Derby side, if I may put it that way. But he’s also now been running the arch hawkish BIS. Central banks, central bank.
Looking for an experienced hand with backbone 00:27:20:02
And it’s also worth noting that the only real reason why these two people are, in my opinion, the only candidates, because remember last time they chose an ECB president who, you know, was the then head of the IMF, that won’t fly this time. They’re going to want someone who has significant monetary policy and monetary policy crisis experience because they - and by ‘they,’ I mean especially the Germans, who are clearly resigned off the record to the fact that it won’t be European, they want someone whom they feel confident will say no to a newly elected French president who goes to Frankfurt and says, you know, I want some monetary easing, some purchases of French government debt. Mission. Policy, initiative, all these types of things, they want someone who they are sure will say no.
Confident in these two choices 00:28:31:20
Think they will feel confident that both Pablo and Klaas will do so. So I think it’s it’s very it’s not that one of these two is going to be or they’re going to be more lenient. Right? Pablo. Klaas is not going to be lenient on France at all; the Spanish, you know, policymakers remember very well what happened to Spain during the Euro-crisis. There is no chance. You know, to go easy on France; and the Dutch. Well, the Dutch will be the Dutch. They’re definitely not going to.
A field of two 00:29:12:07
This was all a long way of saying that between these two candidates, it’s going to come down to, I wouldn’t say politics of the day, but they are very similar on the big issues on the monetary policy outlook and how the ECB will react in a we can debate whether it’s possible or probable, you know, fiscal showdown with France.
Jacob Funk Kirkegaard
Jacob Funk Kirkegaard has been nonresident senior fellow with the Peterson Institute for International Economics (PIIE) since September 2020 and resident senior fellow with Bruegel since September 2024. He was a resident senior fellow with the German Marshall Fund of the United States (GMF) in the GMF’s Brussels office from September 2020 to August 2024. He has been associated with the Institute since 2002 and had been resident senior fellow from 2013 to 2020.
Before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector. He is a graduate of the Danish Army’s Special School of Intelligence and Linguistics with the rank of first lieutenant; the University of Aarhus in Aarhus, Denmark; the Columbia University in New York; and received his PhD from Johns Hopkins University, School of Advanced International Studies. He is coeditor of Transatlantic Economic Challenges in an Era of Growing Multipolarity (2012), author of The Accelerating Decline in America’s High-Skilled Workforce: Implications for Immigration Policy (2007), coauthor of US Pension Reform: Lessons from Other Countries (2009) and Transforming the European Economy (2004), and assisted with Accelerating the Globalization of America: The Role for Information Technology (2006). His current research focuses on European economies and reform, immigration, foreign direct investment trends and estimations, pension systems, demographics, offshoring, and the impact of information technology.
