ECB’s Schnabel: ‘Monetary Policy Should Proceed Gradually and Remain Data-Dependent’

16 December 2024

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Isabel Schnabel on Monday made the case for monetary authorities to continue acting gradually so as to ward off economic weakness while making sure that inflation continues to descend to target.

In a speech at the CEPR Paris Symposium 2024 hosted by the Banque de France, Schnabel, according to a text made available by the ECB, argued that ‘with interest rates approaching neutral territory and with risks to the inflation outlook broadly balanced, monetary policy should proceed gradually and remain data-dependent.’

This was the way to ‘ensure that disinflation does not stall above our 2% target, while avoiding unnecessary weakness in the labour market and the economy at large’, and had motivated last week’s decision, she said.

The incompleteness of disinflation was one factor warranting a gradual approach, Schnabel argued, citing high services inflation. Although the three-month moving average pointed to deceleration here, this could be a quirk of the seasonal adjustment, potentially made more difficult by pandemic-related consumption shifts, she said.

‘[E]ven if most of the evidence points to continued disinflation, we should remain alert to signs that cast doubt on our baseline’, she said. ‘A gradual approach allows us to react to such signs.’

New shocks also justified easing only gradually, she said, pointing to higher gas, electricity and food prices as well as to the medium-term inflation impact of climate mitigation. Tariffs could also prove inflationary on balance, and the euro’s recent depreciation was ‘already putting upward pressure on import prices’, she said.

‘Such inflationary shocks are of particular concern in the current environment, as people are paying more attention to inflation after recent experiences’, she said. ‘This attention makes inflation expectations more vulnerable after a long period of high inflation’, but cutting rates gradually permits policymakers to respond as needed.

Gradual easing was also appropriate as the ECB approached neutral territory, she said, mentioning ECB and BIS research that indicated nominal r* could be in the 1.5% to 3% range.

Given such uncertainty, it was proper to consider whether r* might have risen over the last few years, as if it had, this would also argue for gradualism, she said. Changes related to global savings that implied the need for higher real market-clearing interest rates spoke for such a rise, she said.

‘This may especially be the case as rising geopolitical fragmentation contributes to reducing the supply of savings, including those provided by price-insensitive investors’, she said, noting that the drop in the share of foreign official holdings of US Treasuries had gained speed in recent years and was now at a more than 20-year low.

The upshot, she said, was that ECB interest rates ‘may already be in neutral territory, as real spot rates have started to fall below their equilibrium levels.’ The bank lending survey backed this view, as it showed 93% of banks, many more than a year ago, minimising the importance of interest rates as a reason for weak loan demand, she said.

‘All this suggests that we should proceed with caution and remain data-dependent, assessing at each monetary policy meeting whether disinflation remains on track and whether, and to what extent, interest rates remain restrictive’, she said. ‘In doing so, we can continuously cross-check the assumptions underlying the staff projections and thereby retain a forward-looking perspective.’

According to Schnabel, when the inflation environment had reverted to one in which random shocks were the norm, with price stability sustainably restored, policy would have to ‘carefully weigh the benefits and costs of trying to lean against relative price shocks.’

In this environment, policy could countenance ‘moderate deviations’ from the price stability target.

Disinflation in the euro area remained ‘well on track’, while growth, albeit weaker, would strengthen in 2025, she said. Higher-than-expected GDP in 3Q, in particular with private consumption up and inventories signalling a turnaround, and recently improved confidence among retailers along with lower intended savings and expanded major purchase plans should all support a recovery, she said.

Moreover, models suggested that recovery was ‘still much more probable’ than recession during the next year, even with the threat of tariffs, she said.

After past shocks had been completely digested, there should be no significant over- or undershooting of the ECB’s 2% target, she said.