By Marta Vilar – LONDON (Econostream) – European Central Bank Executive Board member Isabel Schnabel said on Thursday that the ECB could have to tighten monetary policy if the energy shock linked to the conflict in the Middle East spreads more broadly through the economy, as risks of second-round inflation effects have risen in recent weeks.
In a speech at the Fifth Annual Charles Goodhart Lecture in the London School of Economics, Schnabel said recent surveys indicated that the energy shock was prompting a growing number of European companies to increase prices, even as it was also weakening demand.
She added that in the meantime, there were also renewed signs of supply chain disruptions.
“Household inflation expectations are also adapting rapidly,” she said. “In March the median euro area consumer expected inflation three years ahead to be 3%, a level similar to that observed in 2021-22, while mean expectations reached an all-time high.”
According to Schnabel, the persistence of memories from the recent inflation episode meant that price shocks were likely to spread through the economy more quickly than they had in 2021.
She said financial markets’ reassessment of the interest rate outlook had helped keep long-term inflation expectations anchored around the ECB’s 2% target, reflecting confidence in the central bank’s credibility.
“If the energy price shock broadens, monetary policy will need to tighten to contain the risk of second-round effects threatening medium-term price stability,” she said. “This risk has increased in recent weeks.”
With negative supply-side shocks expected to occur more often, central banks must carefully preserve the credibility and flexibility they gained during the pandemic era — particularly their ability to raise interest rates whenever their mandate demands it, she said.
Schnabel said this ability could face rising pressure from fiscal and financial dominance, “either of which could, under certain conditions, narrow the room for policy action in the future.”
On central bank independence, she said recent political attacks on central banks were “deeply disconcerting” because they risked weakening confidence in institutions responsible for controlling inflation.
She argued that the threat to central banks was no longer limited to overt political interference, adding that structural economic changes were also undermining the ability of monetary authorities to act independently.
High levels of public debt posed one of the biggest long-term threats to monetary independence, she said, pointing to aging populations, rising defense spending and the costs of green and digital transitions as factors likely to push debt even higher over coming decades.
Schnabel warned that if governments failed to maintain sustainable fiscal policies, central banks could eventually come under pressure to finance public debt through monetary policy.