ECB Insight: Schnabel, a Bit More Forcefully, Invokes the Potential for an Inflation Recovery

13 September 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Isabel Schnabel on Monday combined strong rhetoric from both sides of the hawk-dove spectrum of the ECB’s Governing Council as she once again, though in more forceful terms, put on notice those anticipating persistently weak inflation.

In a speech at a forum for business executives, Schnabel built on substantially similar remarks she had made on July 3, at which time she already identified ‘some ground for cautious optimism that the euro area economy may eventually escape the low growth, low inflation environment that has dominated the macroeconomic landscape for most of the past decade’.

That theme re-emerged on Monday, but with notably more insistence. This is important, given that the intervening two months have produced a new strategy with which the ECB’s monetary policy is now aligned; a continued improvement in the policy-relevant macroeconomic environment; and generally more hawkish tones from the Eurotower.

Even for that context, Schnabel got off to a relatively hawkish start, highlighting improved sentiment in her very first sentence and promptly noting that this improvement was occurring despite data indicative of a deteriorated public health situation.

‘At the same time, consumer prices are increasing at a faster pace, following years of very low inflation’, she continued in the same vein, as if to suggest that it was not out of the question that the euro area was in a new situation with respect to price pressures.

Even as she dismissed ‘inflation fears’, Schnabel acknowledged the possibility that currently more robust HICP, which she saw as potentially ‘positive news’, might not be purely temporary.

‘There are good reasons to assume that the current constellation of fiscal and monetary policy in the euro area may finally chart the path out of the low interest rate environment’, she said.

Schnabel was at pains to reject a hasty monetary policy response in the absence of what she called ‘the slightest indication that the current monetary policy will lead to inflation permanently exceeding 2%’, an assurance rendered all the more credible precisely by the overall hawkish tone of her remarks.

Prematurely tightening policy could prove ‘disastrous’, throttle the incipient upturn and make worse the aftermath of the pandemic, she said. The point of the drastic language: ‘So we will act carefully and cautiously in the current environment.’

And then an important qualification: ‘But this is not to say that interest rates will necessarily remain low for an indefinite period of time.’

Schnabel, who has filled the gap left by Chief Economist Philip Lane’s reticence and become something of a policy spokeswoman for the ECB, did not leave it at the vague and oft-repeated truism that official borrowing costs must eventually head up.

‘Although we assume in our baseline scenario that inflation will fall back below 2% in the medium term, we are very diligently monitoring whether the underlying forecast assumptions might not underestimate the possibility of higher inflation over the coming years’, she said.

Again she dismissed the possibility of runaway price growth, but stuck gamely to the message that inflation can nonetheless surprise on the upside for a change.

‘The real question is whether we can reach our inflation target of 2% any sooner than we are now forecasting’, she said. ‘Inflation of 2% in the medium term would be good news for the euro area. It would pave the way out of the low interest rate environment.’

Potentially prolonged supply constraints, implications of the pandemic for structural growth and changing financial market sentiment all ‘call for our particular attention’, she said.

Echoing again her July 3 speech, Schnabel reiterated the view that there were ‘mounting signs’ that monetary and fiscal policy would, working together, enable an ‘escape’ from low inflation.

When this would occur remained uncertain, and the ECB would not give early signs of an inflation revival any benefit of the doubt, she assured: ‘We will only start the normalisation process when we are confident of reliably reaching our inflation target.’

‘But should inflation sustainably reach our target of 2% unexpectedly soon, we will act equally quickly and resolutely’, she said.