ECB’s Schnabel: Will Tolerate Higher Interest Rates Only if No Threat to Recovery

17 March 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Isabel Schnabel said the ECB would accept higher interest rates only if they did not pose a threat to the economic recovery.

In an interview with French financial daily Les Echos posted to the ECB’s website, Schnabel said that the decision in December to target the preservation of favourable financing conditions did ‘not mean that we target a specific yield level.’

To put changes in financing conditions in context, the ECB must consider whether yield increases are being caused by a brighter outlook, higher commodity prices or the new fiscal stimulus package in the U.S., she said.

‘Overall, recent changes in risk-free rates have been consistent with an improving growth outlook’, she said. ‘Rising inflation expectations have been a key factor driving yields higher, signalling that the policy measures in place are bearing fruit.’

Although financing conditions remain historically accommodative, the speed with which yields were rising ‘was a source of concern’ that ‘risked a premature and too abrupt withdrawal of policy support, which could have choked the incipient recovery’, she said.

‘We will tolerate higher interest rates only if they do not risk slowing the recovery’, she added.

Under circumstances of elevated uncertainty and feeble demand, ‘it is important to protect our policy stimulus’ from any threat that the market ‘may get ahead of itself’, she said.

It is not true, however, that the ECB has ‘defined a threshold above which we have to respond’, she said.

Schnabel denied that the decision to increase the pace of asset purchases had been difficult, saying it had been reached ‘in the end’ by ‘full consensus’ as ‘[e]veryone was aware that we needed to act, and nobody opposed this.’

She defended the decision not to pre-commit to precise purchase amounts so as to preserve the flexibility of the pandemic emergency purchase programme (PEPP) and ‘adjust our asset purchases according to market conditions.’

Markets would ‘learn quickly’ how the ECB preserves favourable financing conditions, and the ECB was ‘sufficiently credible such that market participants knew we would react if needed’, she said.

To assess the favourability of financing conditions, it is necessary to ‘examine a broad dashboard of indicators among which sovereign yields and risk-free rates play a prominent role’ and then consider changes in these in the context of economic developments, she said.

‘An increase in interest rates, for example, could be a result of an upward shift in inflation expectations’, she said. ‘This would be a sign that our measures are working. That’s why we need to understand what is behind the changes measured by our indicators.’

The PEPP will be ended ‘[w]hen we judge the pandemic crisis phase to be over, and when we have managed to counter the shock to the inflation path’, she said, with the task of ensuring a return to price stability left to the ECB’s other tools.

Schnabel indirectly voiced concern about delays in the vaccination campaign, saying that ‘t]he recovery crucially depends on the pace of vaccinations.’

Although the short-term economic situation has deteriorated, she observed, she did not sound too pessimistic as she noted the adaptation of the economy to containment measures and predicted positive effects from the U.S. stimulus as well as additional fiscal support in Europe.

‘All of this leads us to expect a firm rebound of economic activity in the second half of the year once the containment measures are lifted’, she said, reiterating expectations of a return to pre-pandemic output levels by mid-2022.

European fiscal support could ‘turn out to be insufficient’, but ‘the discussion is premature’, she said. It is ‘absolutely fundamental’ that disbursement occur as soon as possible, and even more important that use of the funds raises potential growth, she said.

European stock market levels are not a source of concern yet, she said, suggesting that U.S. equity markets could be overdoing it.