ECB's Next Move Hinges on Energy Prices, Demand, and Global Borrowing Costs

European Central Bank (ECB) board member Isabel Schnabel emphasized the importance of closely studying key factors in deciding whether to implement more interest rate hikes. The ECB has already raised rates twice this year, following an energy price surge that pushed inflation above its 2% target.

The first factor is how persistent a rise in energy prices would affect inflation expectations, particularly after a prolonged period of high inflation since the pandemic. Schnabel noted that while repeated episodes of high inflation make prices more salient and could prompt households to increase their own price or wage expectations, most measures of longer-term inflation bets remain around 2%, partly due to the ECB's rate hikes.

She also highlighted the need to consider whether overall demand in the economy will remain resilient in the face of higher costs. Additionally, Schnabel pointed out that the recent surge in global borrowing costs, driven by rising interest rates, could impact the economy more than predicted by the ECB.

Schnabel did not explicitly state her preferred policy path but suggested that if expectations are firmly anchored and backed up by a track record of delivering on the inflation target, monetary policy can tolerate a more gradual return to the target. She noted that some models indicate the economy could respond more to the recent tightening than currently assumed, which would dampen medium-term inflationary pressures compared with the baseline projection.