ECB Insight: Schnabel Avoids Being Too Explicit, but Hawkish Tone Inescapable

31 August 2023

By David Barwick – FRANKFURT (Econostream) – Not being the table-pounding sort, European Central Bank Executive Board member Isabel Schnabel prefers to articulate her policy preferences dressed in the more scholarly arguments typified by her speech on Thursday – from which we nonetheless draw the conclusion that she is leaning towards another rate hike next month.

 

Nowhere, of course, did she explicitly state as much. Indeed, she extolled the ECB’s data-dependent approach as ideally suited to react to the vicissitudes of the economy under circumstances of massive uncertainty, suggesting that for her, the optimal outcome of the monetary policy meeting two weeks from today could remain up in the air to the end.

 

And well it might, but our supposition all along that Schnabel is likely to favour additional tightening without any September pause (see our latest member-by-member tally of the Council) finds ample support in her latest intervention.

 

We note, for example, that whenever Schnabel conceded a dovish point, a ‘but’ or something of the sort was likely to follow closely, signalling a hawkish rebuttal that invariably enjoyed the last word, e.g.:

 

  • ‘Activity has moderated visibly, and forward-looking indicators signal weakness ahead. But important pockets of resilience remain, especially the labour market.’
  • ‘Headline inflation has come down, mainly on the back of previous supply-side shocks unwinding. But underlying price pressures remain stubbornly high, with domestic factors now being the main drivers of inflation in the euro area. Therefore, a sufficiently restrictive monetary policy is critical for bringing inflation back to our 2% target in a timely manner.’
  • ‘…developments point to growth prospects being weaker than foreseen in the baseline scenario of the June Eurosystem staff projections. At the same time, there are indications that the euro area economy may not be on the brink of a deep or prolonged recession.’

 

But the impression that Schnabel is leaning towards another rate hike hardly relies on rhetorical idiosyncrasies. Rather, her key message – that policy needs to be data-dependent and consider the entire distribution of risks to inflation – is anything but neutral.

 

The ‘exceptionally large degree of uncertainty about the medium-term inflation outlook’ she observes is namely not a delicate balance around the central scenario in which divergent outcomes are subject to a symmetric probability distribution.

 

Whilst in the ECB’s latest survey of professional forecasters, which she appealed to, the ‘wide range of views reflects risks in both directions’, she devoted more than twice as much text to the upside risks, of which she listed several in partly alarming language, than to those of the downside kind, of which she noted one in a neutral tone.

 

At this point, any notion that upside and downside risks are confronting monetary policy on an equal basis went out the window.

 

‘On net, respondents in our survey of professional forecasters judge that the balance of risk for inflation in 2025 remains tilted to the upside’, Schnabel said. ‘Moreover, respondents also see upside risks to inflation over the longer term.’

 

Expectations for 2028 entail a ‘significant probability’ of inflation exceeding 2.5%, and financial market option prices also indicate long-term upside risks, she continued.

 

The ECB will ‘carefully weigh these and other relevant risks’, according to Schnabel, and if monetary policy is not seen as being calibrated to ensure price stability’s timely return, then ‘a further increase in interest rates would be warranted.’

 

That would have the benefit of warding off persistently high inflation in ‘an environment of tight labour markets and structural inflationary headwinds’, she added.

 

To be sure, Schnabel acknowledged the possibility that the ECB could find that ‘the pace of disinflation is proceeding as desired’, a scenario dealt with however in a single sentence, in marked contrast to the alternative to which she paid substantially more attention.

 

And lest the reader not realise what type of economic developments Schnabel sees as putting a premium on a data-dependent approach to monetary policy, she warned that risk-free rates across the maturity spectrum had decreased to the level of early February in the wake of updated investor expectations.

 

‘This decline could counteract our efforts to bring inflation back to target in a timely manner’, she said. ‘By setting monetary policy meeting-by-meeting, with an open mind and based on the incoming data and an assessment of the risks to the inflation outlook, we can take such developments into account to ensure that the key ECB interest rates are set at sufficiently restrictive levels for as long as necessary to achieve a timely return of inflation to our 2% medium-term target.’

 

We always assumed that Schnabel would be among those preferring not to pause in September, and see her speech today as confirmation.