By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Isabel Schnabel said Wednesday that central banks cannot wait for indirect and second-round effects from the latest energy shock to become visible before responding, but must judge in advance how the shock will feed through to underlying inflation and calibrate monetary policy accordingly.

“Central banks cannot wait for these effects to materialize,” Schnabel said in a speech in Luxembourg. “If policymakers waited for firms to visibly raise prices and wage negotiations to conclude, they would be acting too late.”

Since the cut-off date for the ECB’s September projections, oil and gas prices had moved closer to the adverse scenario, implying “a larger and more persistent deviation of inflation from our 2% target,” she said.

The September projections foresee headline inflation falling from 3.0% in 2026 to 2.1% in 2028, while inflation excluding energy and food is expected to rise to 2.6% in 2027 before declining to 2.3% in 2028, Schnabel noted.

That core inflation profile assumes a gradual accumulation of indirect effects and some second-round effects from persistently higher energy prices as companies pass some of the additional costs on to consumers, she said.

Compared with projections made before the Middle East conflict, ECB staff have raised projected inflation excluding energy by a cumulative 1 percentage point, mainly because of indirect effects and, to a lesser extent, expected second-round effects through wages, according to Schnabel.

Higher import and producer price inflation, particularly for intermediate and capital goods, already provided “first evidence that higher input costs are being passed through successive stages of the production chain, although this is not yet visible in core inflation,” she said.

Against that backdrop, raising interest rates twice since June had been appropriate, Schnabel said.

While adverse supply shocks weaken output as well as raising prices, it would often be inappropriate for central banks simply to look through them, she argued. If such a shock were sufficiently large or persistent to lift the projected inflation path above target, monetary policy should tighten to bring inflation back to target, she said.

“[T]he nature of the shock determines the appropriate speed at which inflation should be brought back to target, not the need to respond at all,” Schnabel said.

The appropriate policy response depended in part on inflation expectations, she said. Firmly anchored expectations allowed monetary policy to tolerate a more gradual return to target, while signs that expectations were becoming less firmly anchored could require “a more forceful response” to prevent temporary shocks from becoming persistent, she said.

Medium- and longer-term household inflation expectations remained above their pre-conflict levels, Schnabel said, though most measures of long-term expectations were still close to the ECB’s 2% target.

Incoming data would now need to show whether the projected pass-through was occurring as expected, with policymakers particularly focused on inflation expectations, the resilience of aggregate demand and the economic effects of higher short- and long-term interest rates, she said.

The possibility that recent tightening could have a greater economic effect than assumed in the staff projections represented a countervailing consideration, according to Schnabel. Some models suggested stronger monetary transmission, particularly to gross domestic product, meaning the economy could respond more strongly to higher rates and thereby generate less medium-term inflation than projected, she said.

At the same time, robust credit growth suggested either that financial conditions were not yet restrictive or that some lending, particularly for artificial intelligence investment, had become less sensitive to interest rates as expected returns increased, she said.

“The coming months will provide a clearer picture” of how far pipeline price pressures feed into underlying inflation and inflation expectations and how the economy responds to the rate increases already delivered, Schnabel said.

Those developments would guide the calibration of the ECB’s policy stance to ensure that the current shocks did not become embedded in broader and more persistent inflation, she said.