The European Central Bank Goes Big on a Rate Hike

Ms. Lagarde was later than most of her peers to act against this danger, but now she’s moving with alacrity and credibility—to an extent. She surprised markets in July with a half-percentage point rate increase when investors had expected only a quarter-point rise. She has been more disciplined than Federal Reserve Chairman

Jerome Powell

in her refusal to offer forward guidance that might confuse markets into doubting her resolve.

But notably missing from Thursday’s announcement was an indication of when the ECB might start shrinking its balance sheet by running off maturing government and other bonds it has bought under its two quantitative-easing programs. The closest Ms. Lagarde will come is to repeat that maturing principal in the more recent of the two, the Pandemic Emergency Purchase Program, will stay on the books at least until the end of 2024. There’s no timeline for paring back bonds acquired under the original Asset Purchase Program.

The main reason for the delay on quantitative tightening appears to be concern that government borrowing rates would go haywire if the ECB removes this support. Ms. Lagarde plans to create a new mechanism to subsidize debt from euro members such as Italy to avoid this, but for now the ECB is reinvesting maturing principal from the pandemic QE program “flexibly,” which is code for diverting most of that cash to purchases of new Italian debt. The ECB seems afraid of what might happen if markets are able to price eurozone risks again.

Ms. Lagarde has to hope rate increases will be enough to tame eurozone inflation before the ECB needs to make tougher decisions on quantitative tightening. And before the political backlash against rising unemployment makes fighting inflation more difficult.