The confidence the ECB cannot buy

On September 10th the European Central Bank raised its deposit rate by a quarter point to 2.5%, its second hike in four months, and Christine Lagarde, its president, chose the occasion to reassure. The economy was "proving resilient", she said. "Consumer confidence has rebounded." The decision, she added, was a "no-brainer".

Read it as she wants it read and the story is flattering. The ECB can fight inflation and keep the household intact. Look at the numbers behind the phrase and the confidence turns out to be the revealing detail, not the reassuring one. This is a central bank tightening into a war-driven energy shock, and the sentence at issue is who ends up paying.

The inflation is not of the usual sort. Headline euro-area prices rose 3.3% in August; energy inflation alone hit 14.3%, the product of the war in the Middle East and threats to shipping through the Strait of Hormuz. A net energy importer, the euro area is importing a cost spike. The ECB now sees underlying inflation, stripped of energy and food, at 2.5% this year and 2.6% in 2027, while economists do not expect inflation to return to its 2% target until late 2027.

Textbook economics is unimpressed by this sequence. Raise rates against a supply shock and you do not make barrels cheaper or the strait safer; you suppress demand, raise borrowing costs and court a recession to fix nothing. The IMF has been warning since the spring that the energy shock is weighing on growth. The concession everyone grants the ECB is real—but so is the corollary it prefers not to advertise.

For the higher rates are not free; they are distributed. Households pay at the petrol pump regardless. Borrowers pay on mortgages. And governments pay on their debt, at exactly the moment a war argues for more public spending. European bond yields have surged to 15-year highs, and France has displaced Italy as the focus of investors' worries about debt sustainability, with 10-year borrowing costs near Italy's, a tricky budget ahead and an election due next year. A "no-brainer" for the central bank is a load-bearing bill for the euro area's most indebted treasuries.

That is the quiet cost hidden inside the confidence rebound. Consumer confidence did improve—to -15.5 in August, its fourth monthly rise and its best since February—and the ECB is entitled to cite it as evidence that demand can absorb tighter money. It is also a measure the central bank both influences and needs: a rebounding household gives the hawks cover to claim that the burden of restraint is bearable and blameless.

The harder question is what comes next, and here the confidence evaporates into disagreement. In a Reuters poll of 65 economists, 91% expected the deposit rate to end 2026 at 2.5%, and 78% saw it holding through mid-2027—a conviction that September was the last hike of a deliberately short campaign. Rate futures, however, price a third move, and a Deutsche Bank survey produced terminal-rate guesses as high as 3%. Strategists at Aviva and JPMorgan see more tightening to come, with Lagarde's own admission that inflation stays sticky until late 2027 lending their side of the argument its numbers.

The stakes of that disagreement are what a holder of European assets is really buying. If the "done" camp is right, the hawkishness is behind the market and the tail risk is fiscal—the French and Italian treasuries that must refinance at 15-year highs. If the futures market is right, the cost moves into growth, and the consumer confidence that justified September's hike is the first number to roll over.

For a U.S. investor the exposure is mostly indirect: the euro, a European equity fund, the read-through to global rates. On the currency, a still-hawkish central bank with high real yields supports the euro, which flatters a dollar-based return. On everything else, the variable that matters is not a confidence index published on a Tuesday but the war in the Middle East and the politics of Europe's most indebted governments. The ECB has bought itself the right to call its tightening a no-brainer by borrowing against those two. The bill will present itself elsewhere.