ECB’s Schnabel: 50BP Hike in March ‘Necessary Under Virtually All Plausible Scenarios’

17 February 2023

By David Barwick – FRANKFURT (Econostream) – The European Central Bank will almost inevitably have to hike interest rates by 50bp next month, when it might provide some indication of its subsequent policy moves, according to ECB Executive Board member Isabel Schnabel on Friday.

In an interview with Bloomberg, Schnabel pointed to core inflation’s persistence and strength as well as to the present level of official borrowing costs to argue that a 50bp hike in March ‘is necessary under virtually all plausible scenarios in order to bring inflation back to 2%.’

This was consistent with being data-driven, she reasoned, ‘because it is very unlikely that the incoming data is going to put this intention into question.’

After March, monetary policy steps depended on what level the ECB would have to reach for rates to be restrictive enough, and on how long policy had to stay there, she said.

Determining the terminal rate would be a matter of seeing in the data that policy is restrictive, she said. Most important in this respect was the stage of policy transmission from financing condition to aggregate demand, she said.

‘Recent data show some weakening of the economy towards the end of last year, but the question is whether, and to what extent, this was driven by our monetary policy or whether it was predominantly a consequence of the energy price shock’, she said.

Monetary policy had not yet become sufficiently restrictive, she suggested, noting that the latest tightening of credit standards was not driven by banks’ funding costs.

‘And now that the economy is proving more resilient, part of these factors may even reverse and counteract our intentions to reign in loan demand’, she said. ‘Therefore, it is not so easy to judge whether our measures are already restrictive.’

With the job market ‘very strong’, she said, only the housing market had clearly weakened due to ECB monetary tightening. ‘We do not yet see such trends more broadly’, she said. ‘I think that in May we will have a clearer picture on that.’

Once reached, the terminal rate would be maintained ‘until we see robust evidence that inflation — and in particular underlying inflation — is going back to our target of 2% in a timely and durable manner’, she said.

‘A turning point in underlying inflation is not sufficient because this turning point is likely driven by the gradual pass-through from lower energy prices to underlying inflation rather than the more persistent components’, she said. ‘Over the medium term, inflation will mainly be driven by wage and profit developments.’

Whilst pleading ignorance about the likelihood of any guidance next month on the May outcome, Schnabel conceded that ‘it can be useful to give an idea about the direction of travel.’

For her to countenance a deceleration to 25bp in May, the evidence from lending markets, job markets and the elements of aggregate demand would have to show that ‘our monetary policy is becoming restrictive’, she said.

However, the unusual nature of the present hiking cycle left open the question of how rate hikes translated into lower aggregate demand, she said. ‘We may have to act more forcefully if transmission turns out to be weaker’, she said.

Whilst personally inclined to view transmission as weaker, if it is merely delayed, the ECB can always react accordingly, she said. ‘We have the option to lower rates again if we get the impression that our monetary policy stance is getting too restrictive’, she said. ‘From today’s perspective, that is nothing I foresee anytime soon.’

Schnabel declined to endorse the terminal rate expectation of markets, saying that these assumed a rapid descent of inflation to a stable 2% at little economic cost.

‘That would be a very good outcome, but there is a risk that inflation proves to be more persistent than is currently priced by financial markets’, she said. ‘As regards the terminal rate, we need to look at the incoming data to see how far we need to go.’

The ECB continues to want to reduce its balance sheet ‘in a measured and predictable way without causing any disturbances’, according to Schnabel. ‘So, it is not so much determined explicitly by stance considerations because this is not our main stance tool, but it is decided in a more technical way. It is clear that QT tends to have an effect on the longer end of the yield curve. But it is not that we are steering the slope of the yield curve. That is not the way we think about it.’

As QT is proceeding gradually, the ECB is ‘still quite far away from the point where the size of our balance sheet may affect our ability to steer short-term interest rates’, she said. ‘This gives us a bit of time, but it is important, at some point, to give an indication where we think the balance sheet is going to end up.’