NEW YORK: The European Central Bank (ECB) must keep a close eye on upside inflation risks stemming from geopolitical events like the war in Iran, though it doesn’t have to react as long as price growth remains reasonably close to target, Executive Board member Isabel Schnabel says.
With inflation projected to meet the 2% goal over the medium term and consumer expectations anchored, “monetary policy remains in a good place,” Schnabel said last Friday in New York.
But the ECB “cannot be complacent,” she added, with the Middle East escalation making the price outlook more uncertain.
“We need to be vigilant as the current geopolitical and macroeconomic environment creates upside risks to inflation over the policy-relevant horizon,” Schnabel said.
“In particular, we must carefully monitor the persistence of the energy-price shock, its impact on inflation expectations and any indication that firms start passing through higher input costs to their customers.”
At the same time, Schnabel, one of the most hawkish members on the ECB’s Governing Council, stressed that temporary and small deviations from the target “are of limited relevance for policy decisions” as long as consumers don’t raise their expectations.
The comments come less than two weeks before the next interest-rate meeting, when policymakers must decide how to deal with the war in Iran and the accompanying surge in energy prices.
While it’s likely to push euro-area inflation up, it may also dampen economic activity – threatening stagflationary scenarios.
So far, most officials say it’s too early to draw conclusions, arguing that the economic impact will largely depend on the duration of the conflict.
But some stress the ECB’s readiness to act if needed. Investors are pricing in a rate hike already this year.
In 2022, Russia’s war in Ukraine triggered an energy shock and a spike in consumer-price growth to a record 10.6%.
Like other central banks around the world, the ECB responded with unprecedented tightening. Until recently, it was projecting that inflation would stabilise at about 2%.
“The situation today is quite different from what we had in 2022,” Schnabel said. While there are some similarities, “I wouldn’t push that too far, because the energy pressure is much smaller.”
The question is whether the upswing in oil and gas prices turns out to be persistent, she said, adding that such a shock would probably make inflation deviate from the ECB’s goal.
In her speech, Schnabel stressed that the ECB’s price-stability mandate is “well-equipped and robust to deal with the challenges central banks face today.”
“It provides a firm anchor in a world marked by more frequent supply-side shocks, and it is flexible enough to accommodate temporary deviations from target while keeping policy firmly focused on the medium term,” she said. — Bloomberg
She also said “the lessons from the pandemic suggest that central banks should resist the temptation to fine-tune the economy, accommodate fiscal policy or deliberately run the economy hot in pursuit of marginal short-term gains.”
The costs of misjudgment can be “significant,” she warned. “Credibility, once eroded, is difficult to rebuild.” — Bloomberg
