The European Central Bank has “limited” room to raise interest rates in smaller increments because government policies to cushion households and businesses from soaring energy prices will keep eurozone inflation higher for longer, according to a senior policymaker.
Isabel Schnabel, an ECB executive board member, warned that market expectations of a shift to smaller rate rises at its meeting next month had lowered borrowing costs, making it harder to move to a slower pace of monetary tightening.
Signalling her desire to continue with rate rises of 0.75 percentage points, Schnabel told a conference in London that “the largest risk for central banks remains a policy that is falsely calibrated on the assumption of a fast decline in inflation, and hence on an underestimation of inflation persistence”.
Schnabel said the impact of government support measures meant the ECB would have “to raise rates further, probably into restrictive territory”, whereby growth would be constrained, to bring eurozone inflation down from a record level of 10.7 per cent in the year to October and back to its 2 per cent target.
“Many fiscal measures that are popular among the electorate, such as tight price caps or broad-based subsidies, risk fuelling medium-term inflation further,” she said, adding that this “could ultimately force monetary policy to raise interest rates beyond the level that would be seen as appropriate without fiscal stimulus”.
With expectations rising that eurozone inflation will soon peak as the currency bloc is forecast to enter a recession next year, investors are pricing in a high probability of the ECB raising rates by 0.5 percentage points next month after 0.75 percentage point increases at its last two policy meetings.
However, Schnabel said: “Markets’ expectations of a ‘pivot’ have recently worked against our efforts to withdraw policy accommodation, bringing the actual policy stance further away from the stance that is required to bring inflation back to target.”
The former German economics professor, who is recognised as the most hawkish ECB board member, said: “Incoming data so far suggest that the room for slowing down the pace of interest rate adjustments remains limited, even as we are approaching estimates of the ‘neutral’ rate.”
ECB officials estimate the neutral rate — a level that neither stimulates nor constrains the economy under normal conditions — is as high as 2 per cent in the eurozone. The ECB lifted its deposit rate to 1.5 per cent last month, meaning its next move could pass this threshold.
Schnabel’s comments underline the potential for a clash at the ECB’s rate-setting meeting next month, with policymakers split between keeping up the pace and switching to smaller increases on the back of signs of a recession.
Austria’s central bank governor Robert Holzmann told the Financial Times this week that he thought the ECB should raise rates by another 0.75 percentage points. But others, such as Mário Centeno at the Portuguese central bank, have called for it to shift to smaller rate rises.
The minutes of last month’s ECB meeting, published on Thursday, revealed intensifying concern among governing council members about “an increasing risk that inflation might become entrenched and that second-round effects and a wage-price spiral could emerge”.
Last month’s 0.75 percentage point rate rise by the ECB was supported by “a very large majority” of its council members, with only “a few” voices calling for a smaller move.
“The tone of the meeting account contrasts with the markets’ initial relatively dovish interpretation of October’s press conference and clearly signals that policy tightening has some way further to go,” said Ken Wattret, an analyst at S&P Global Market Intelligence.
Since then, a sharp fall in European wholesale energy prices combined with an easing of supply chain bottlenecks has encouraged hopes that eurozone inflation could be about to peak, especially after price growth in the US slowed in October.
Business confidence in Germany rebounded more than expected this month as fears of energy shortages receded and supply chain constraints eased, according to the Ifo Institute’s survey published on Thursday.