Iran war threatens ECB's 'good place,' schnabel warns

ECB Faces Heightened Inflation Risks as Iran War Impacts Energy Prices

ECB Policy Response and Inflation Outlook Amid Geopolitical Tensions

FRANKFURT, March 6 (Reuters) - European Central Bank policy remains in a "good place", but geopolitical volatility creates upside risks for inflation, requiring vigilance from the bank, ECB board member Isabel Schnabel said on Friday. 

Market Reactions and Interest Rate Expectations

Financial investors raised their bets this week on an ECB interest rate hike in 2026, as a war-induced spike in energy costs is likely to feed through to consumer prices quickly, lifting inflation above the ECB's 2% target.

Energy Price Volatility and ECB's Stance

While the ECB often looks past energy-driven price volatility, its 2022 experience with runaway prices is seen curbing its tolerance for excessive inflation.

ECB Board Member's Perspective

"With inflation projected to be at our target over the medium term and inflation expectations anchored, monetary policy remains in a good place," Schnabel said in a speech in New York.

"We need to be vigilant as the current geopolitical and macroeconomic environment creates upside risks to inflation over the policy-relevant horizon," she said. "The recent spike in energy prices following the tensions in Iran makes the inflation path more uncertain."

The ECB thus needs to carefully monitor the persistence of the energy price shock, its impact on inflation expectations and any indication that firms start passing higher costs onto their customers, she added.

Upcoming ECB Meeting and Policy Considerations

Meeting on March 19, the ECB will assess the Iran war's impact on the economy, but most policymakers have dismissed the notion that policy action could come as soon as this month.

Schnabel argued that as long as any rise above target is small, temporary, and expectations remain anchored at 2%, then the price volatility is of "limited relevance" for the ECB.

Lessons from the Post-Pandemic Period

Issues may arise when underlying price dynamics and wage developments fall out of sync with the target and the lessons from the post-pandemic period suggest that the ECB must "tread carefully".

Inflation started rising already during the post-pandemic reopening in 2021 but central banks around the world dismissed this as a "transitory" increase, only to be proven wrong when price growth surged into double-digit territory by late 2022.

The ECB was among the last major central banks to respond and raised rates at a record pace from July 2022. However, it was the first among them to tame inflation, which has been at target for most of the past year.

External Factors Influencing Inflation

Impact of Trade Patterns and Imports from China

Schnabel also played down arguments that rising imports from China, part of shifting trade patterns in the world of U.S. tariffs, would push prices down, creating a drag on inflation. 

"ECB staff analysis finds that the estimated impact of trade diversion from China on the euro area is modest and statistically insignificant," she said, adding that even under extreme scenarios, the price impact remains small.

Labour Market Pressures

Prices could also remain under upward pressures from a historically tight labour market, which is likely to tighten further due to rapid ageing, moderating immigration and rising skill mismatches, Schnabel said.

(Reporting by Balazs Koranyi; Editing by Hugh Lawson)