By David Barwick – ROME (Econostream) – European Central Bank Executive Board member Isabel Schnabel on Monday argued that monetary policy could not look through the current shock, since – despite the renewed decline of oil prices – it was already leading to indirect effects and could still become self-perpetuating.

In remarks during a conference at Banca d’Italia, Schnabel described the global economy as being “on a roller coaster this year,” with events in the Middle East leading to higher input costs and fears of another major inflation surge, only for a ceasefire to be reached just as the conflict had appeared likely to endure.

“But does the decline in oil prices mean we are back to the prewar situation?” she asked rhetorically. “I don’t think so. The cease-fire is still fragile. Markets continue to point to higher oil prices over longer horizons. Gas prices are still around 40% higher than before the war.”

“Crack spreads are twice their pre-war levels, and pipeline and supply chain pressures remain elevated,” she continued. “Energy inventories will need to be refilled. And while euro area headline inflation has come down from its peak, core inflation has reacted much less, and its momentum remains strong.”

In the meantime, new shocks were occurring, she said, citing record-high heat in Europe and the super El Niño. These could lead to higher food prices, she warned.

“At the same time, the AI investment boom is humming along, supporting global demand and adding to inflationary pressures,” she said.

Research indicated that the sacrifice ratio associated with any rate move could be lower when supply shocks were inducing companies to increase their prices more often, Schnabel said.

“Hence, it may be best to strike while the iron is hot when faced with large cost-push inflation shocks,” she said. “And while we have not yet seen any clear evidence of changed pricing behavior, this needs to be monitored.”

Schnabel observed that in contrast to the energy shock in the wake of Russia’s invasion on Ukraine, the current shock was global in nature.

“The current shock cannot simply be looked through because it is already generating indirect and potentially second-round effects in spite of the oil price correction,” she said.

“Due to the still fresh memory of the high inflation episode, inflation expectations may be more sensitive to increases in inflation, and firms may be faster to pass through higher input prices,” she said. “This is why the Governing Council raised interest rates at its last meeting, a decision that was robust even under a scenario in which energy prices fell near today's levels.”