In a significant address at Stanford University in California last Friday, Isabel Schnabel, a member of the European Central Bank‘s (ECB) executive board, emphasized the need for a “steady hand” in monetary policy. She cautioned that the ECB must refrain from reducing borrowing costs too drastically, as inflation could surge in the future.
Schnabel stated that maintaining interest rates around their current levels strikes a balance in monetary policy. “By keeping interest rates near their current levels, we can be confident that monetary policy is neither excessively holding back growth and employment, nor stimulating it,” she said. This approach allows the ECB to closely monitor the economic situation and be prepared to act if any risks that could jeopardize price stability materialize. “We are thus in a good place to evaluate the likely future evolution of the economy and to take action if risks materialise that threaten price stability,” she added.
Looking at the medium – term, Schnabel pointed out that inflation risks are “likely tilted to the upside.” This is due to two main factors: the increase in fiscal spending and the potential for renewed cost – push shocks from tariffs that could spread through global value chains. Her remarks come at a time when the ECB has been actively cutting rates. Since June, the bank has reduced rates seven times, and officials have indicated their willingness to do more as US President Donald Trump’s trade tariffs pose a threat to economic growth, with another rate cut seemingly on the horizon next month.
Investors are anticipating two to three more rate cuts this year, and some economists, such as Gilles Moec from Axa Group, expect even more aggressive easing measures, unless trade negotiations conclude quickly and favorably. However, Schnabel’s comments, which were her first public remarks since the April rate reduction and her first in – depth monetary – policy comments since February, served as a reality check on these rate – cut expectations.
Schnabel acknowledged that in the current economic climate, high levels of uncertainty, a sharp drop in energy prices, and a stronger euro are likely to suppress headline inflation in the short term, potentially pushing it below the ECB’s 2% target. In April, consumer – price growth was at 2.2%. But she stressed that monetary policy should focus on the medium term. “Given long and variable transmission lags, reacting to short – term developments could result in the peak impact of our policy only unfolding when the current disinflationary forces have passed,” she noted.
She further highlighted two significant factors that could disrupt the ECB’s inflation goal. Firstly, fiscal policy is set to expand on a large scale, especially with the new German government’s plans. “Fiscal policy ‘is set to expand on a scale unseen outside periods of deep economic contraction’, and overall, the fiscal impulse is likely to put upward pressure on underlying inflation over the medium term,” she said. Secondly, global fragmentation, particularly due to US tariffs, poses risks. Although it is difficult to assess the exact implications while negotiations are ongoing, there is a risk that lasting and significant tariff increases will add to the upward pressure on underlying inflation caused by higher fiscal spending in the medium term.
On a more positive note, Schnabel also suggested that eurozone foreign demand may remain resilient, and trade diversion could potentially boost the bloc’s exports. “Should prohibitive tariffs on Chinese imports remain in place, they will measurably raise the eurozone’s price competitiveness in the US market,” she concluded, offering a glimmer of hope amidst the economic uncertainties.
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