ECB Likely to Raise Interest Rates in June Amid High Inflation and Energy Costs
ECB Policy Outlook and Economic Implications
By Balazs Koranyi and Reinhard Becker
FRANKFURT, May 26 (Reuters) - The ECB should raise interest rates in June, even if ongoing peace talks with Iran yield a deal, as the conflict has been far longer than projected and high energy prices are spilling into the broader economy, board member Isabel Schnabel said.
The European Central Bank has kept rates on hold for the past year, but it debated a hike last month as sharply higher energy costs pushed inflation well above its 2% target, and numerous policymakers have signalled a need for action.
Rationale Behind the Expected Rate Hike
"Given the size and the persistence of the current shock, looking through is no longer an option in my view," Schnabel told Reuters in an interview. "From today's perspective, I think a rate hike in June will be needed."
While the U.S. has signalled progress in peace talks with Iran, Schnabel, a potential successor to ECB President Christine Lagarde next year, said the ECB may be past a point of no return because energy infrastructure has been damaged and high energy prices are feeding through to the broader economy.
Peace Deal Unlikely to Stop Hike
"Even if the war ended today, a lot of damage has already been done to energy infrastructure and global supply chains," said Schnabel, a former university professor. "So, even then, I believe that a monetary policy reaction would be needed."
"In terms of persistence, we have actually moved beyond the adverse scenario, which assumed a rapid normalisation of oil prices," she said.
Inflation and Second-Round Effects
Inflation hit 3% last month with further increases likely and policymakers worry that high energy costs will push up the price of other goods and services via second-round effects, setting off a hard-to-defeat inflation spiral.
Schnabel said some of these second-round effects may already be materialising, as indicated by a number of surveys, including the ECB's Consumer Expectations Survey, PMI data and the EU Commission's sentiment indicator.
"We are seeing increasing signs that the shock is spilling over to other parts of the consumption basket," Schnabel said.
Future Policy Steps and Market Expectations
Beyond June, the ECB should not commit to any policy step and should reassess its stance at every meeting based on data, Schnabel said.
Still, she pointed out that the ECB's own baseline projection included two rate hikes, a hint which may suggest that a single hike may not be enough.
Financial markets have fully priced in two hikes in the ECB's 2% deposit rate and see a roughly 50% chance of a third move over the next year. Economists are more cautious and see just two hikes, followed by a cut in mid-2027, a Reuters poll showed.
Economic Growth Outlook
Economic Growth Looks Weak
A key reason why ECB watchers see only gentle policy tightening ahead is that the euro zone economy remains weak and high energy costs could weigh on its expansion more than feared.
The European Commission last week predicted 0.9% expansion in 2026, a big slowdown from last year and which still may be too optimistic.
Risks to Growth and Inflation
"Given the high persistence of the shock, I believe that the negative impact on economic growth will also be stronger," Schnabel said. "We have seen a sharp decline in confidence indicators, especially among consumers."
"All of these imply downside risks to economic growth and upside risks to inflation," she added.
Financial Market Reactions and Schnabel’s Future
Schnabel, who is responsible for the ECB's market operations, said financial markets were taking developments in stride and the recent volatility in government bond yields was not concerning.
"The increase in bond yields in the euro area is mainly driven by an increase in inflation compensation," she said. "And this partly reflects an increase in inflation risk premia owing to heightened uncertainty about the future inflation outlook."
Regarding her future, Schnabel, whose term at the ECB expires at the end of 2027, said she would be ready to take over as president, if she was asked.
For the text of the Q&A with Schnabel, click here.
