ECB President Lagarde resigns at time of mounting challenges for Europe

By Francesco Canepa and Balazs Koranyi

FRANKFURT, Oct 29 (Reuters) - European Central Bank President Christine Lagarde resigned on Thursday, ending months of speculation about her future just as Europe enters a period of rising economic volatility and divisive electoral politics, particularly in her native France.

Lagarde will step down on February 7, 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.

The move comes as the ECB battles inflation risks from an Iran war-driven oil shock while a sharp rise in bond yields, especially in France, threatens to dampen growth.

"I leave this institution with a sense of good work done and an ECB that is fit for the future," Lagarde, 70, said in a short video shared on social media.

A source with direct knowledge of the matter said Lagarde, a former French finance minister and head of the International Monetary Fund, had resigned so she could weigh in on political matters in France and globally. As ECB president, she was expected to remain neutral to safeguard the institution's independence.

THE 'WRONG SIGNAL' OR 'SENSE OF RESPONSIBILITY'?

Markus Ferber, a German member of the European parliament for the centre-right European People's Party, said Lagarde's early resignation sent "the wrong signal" given high inflation, nervous bond markets and looming elections.

"If the impression arises that such a departure is timed around national elections, it damages trust in an institution that must stand above any domestic political calculation," Ferber, who sits on the parliamentary committee that will confirm Lagarde's successor, said.

By contrast, Marcel Fratzscher, president of German think-tank DIW, said Lagarde was showing "a strong sense of responsibility towards Europe".

"By leaving office early, Christine Lagarde gives European governments and institutions an opportunity to appoint a successor who will safeguard European values and protect the ECB's independence," he told Reuters.

Lagarde has not addressed such matters directly. She has said she would not be a candidate for the French presidency but would advocate for pro-European values in her home country "in whichever capacity" she deemed most efficient.

European Council President Antonio Costa said the process to find Lagarde's successor would begin immediately. 

The appointment is likely to be part of a broader package of top ECB jobs involving the executive board seat of Isabel Schnabel, who will leave in early January, and chief economist Philip Lane, due to depart in May.

COMPETENT CANDIDATES REASSURE MARKETS

The former central bank governors of the Netherlands and Spain, Klaas Knot and Pablo Hernandez de Cos, are widely seen as frontrunners to replace Lagarde. 

"The rumoured successors are both very competent, well established central bankers, so for markets, it won’t matter too much," Piet Haines Christiansen, an economist at Danske Bank, said.    

Financial markets showed little reaction to the announcement, with some analysts noting the ECB had now built a reputation that outlived any of its leaders.

"The ECB is now quite well established, the market is familiar with the way it operates," Goldman Sachs' head of Fixed Income Macro Investing Simon Dangoor said. "Our view is that institutional behaviour is likely to outlast Lagarde, and be quite similar, whoever takes over."

Lagarde's term was scheduled to run until the end of October 2027 but speculation about an early departure had been mounting for months, with the World Economic Forum seen as a likely destination. The WEF declined to comment.

RATE HIKES AND BOND TURMOIL

Lagarde's resignation comes just as the ECB is in the middle of a rate-hiking cycle aimed at preventing an oil-price shock linked to the Iran war from feeding into other prices and wages.

But it must also contend with a surge in government bond yields — especially in debt-laden France — that has pushed up borrowing costs for households and businesses and which Lagarde has said will curb growth and inflation.

Caught between persistent inflation fuelled by a renewed surge in energy costs and deteriorating financing conditions, the ECB is widely expected to keep its deposit rate at 2.5% on Thursday while signalling that another increase, potentially as soon as December, remains likely.

"There is likely a low bar to another hike in December, given the likelihood of another upward revision of the ECB's inflation forecast due to higher energy prices," Oliver Rakau at Oxford Economics said.

The ECB is due to announce its interest rate decision at 1315 GMT on Thursday, followed by Lagarde's regular press conference at 1345 GMT.

Money markets are currently pricing another three rate increases from the ECB by the end of next year, which would take the deposit rate to 3.25%, a level that is widely seen as restricting economic growth.

(Additional reporting by Klaus Lauer in Berlin; Editing by Catherine Evans, Sam Holmes and Toby Chopra)