(Reuters) -The European Central Bank should stop cutting borrowing costs as turmoil in the global economy is fuelling price pressures and inflation was at risk of exceeding the bank’s 2% target in the medium term, ECB board member Isabel Schnabel said on Friday.
The ECB cut interest rates seven times in the past year as inflation has been rapidly retreating, and policymakers have already started to lay the groundwork for another cut on June 5, taking the deposit rate to 2%.
Schnabel, an outspoken policy hawk, poured cold water on those expectations, making an explicit argument for keeping rates unchanged since they are already low enough not to hold back the economy.
"Now is the time to keep a steady hand," Schnabel told a conference at Stanford University. "The appropriate course of action is to keep rates close to where they are today – that is, firmly in neutral territory."
Financial markets see a 90% chance of a rate cut in June and see another cut or two in subsequent months, indicating that Schnabel’s view goes counter to investor bets.
The complication for policymakers is that short-term and medium-term inflationary forces are quite different.
In the near term, inflation could even dip below the ECB’s 2% target given lower energy costs, a strong euro, anaemic economic growth and high uncertainty created by the U.S. administration’s trade war, Schnabel argued.
But monetary policy affects the economy with long lags and by the time further policy easing really impacts the economy, the drag on inflation may have faded, replaced by quite different forces that push up costs, she argued.
Inflation could be boosted by an expected government spending surge, driven by Germany’s pledge to boost defence and infrastructure investment. But more importantly, trade fragmentation, a byproduct of U.S.-imposed tariffs, could also push up costs and boost prices.
"Over the medium term, risks to euro area inflation are likely tilted to the upside, reflecting both the increase in fiscal spending and the risks of renewed cost-push shocks from tariffs propagating through global value chains," Schnabel said.
Schnabel even challenged the argument that U.S. tariffs without European retaliation are net deflationary for the euro area.
"Even if the EU does not retaliate, higher production costs transmitted through global value chains could more than offset the disinflationary pressure coming from lower foreign demand, making tariffs inflationary overall," Schnabel argued.
Retaliation, as already outlined by the bloc, would only magnify this process and keep pressure on prices further out.
By keeping a steady hand, the ECB could buy insurance against a wide range of possible outcomes and this approach would be robust enough to deal with different scenarios, Schnabel argued.