ECB board member Schnabel stated on Wednesday that the ECB needs to be wary of excessive rate cuts, as borrowing costs are already close to levels that no longer suppress the economy, and further cuts could backfire.
Schnabel said in an interview that officials can continue to ease monetary policy, but only gradually, to avoid pushing rates below the so-called neutral threshold. The hawkish policymaker warned that excessive easing could waste valuable policy space.
"Given the inflation outlook, I think if the upcoming data continues to confirm our baseline forecasts, we can gradually shift interest rates towards neutral," Schnabel said. "I want to warn against going too far, as that would enter the realm of easing."
She estimates that the neutral interest rate, which cannot be measured precisely, is between 2% and 3%, higher than the levels hinted at by more dovish officials such as the Governor of the Bank of Greece, Stournaras, and the Governor of the Bank of Portugal, Centeno. After a 75 basis point cut so far this year, the deposit rate in the euro area is 3.25%. Schnabel stated that current rates are 'probably not too far away' from neutral levels.
After Schnabel made the above comments, the money market reduced its bets on an ECB rate cut, expecting it to cut rates by only 146 basis points by the end of 2025, down from 150 basis points previously. The euro continued to rise, up 0.5% to around 1.0540, while the yield on Germany's two-year bonds erased earlier losses.
These remarks sparked an intense debate on how the European Central Bank should respond to the deterioration of the eurozone economy. Meanwhile, although inflation in the region is approaching the 2% target faster than previously expected, it is not entirely reassuring.
Discussions about the ECB's easing pace are intensifying, with rising global uncertainty complicating the situation further—especially in the context of potential trade tariffs after Trump's return to the White House.
Investors expect the ECB to cut rates to around 1.75%, and Schnabel acknowledged that this does not align with her own assessment. Economists surveyed by Bloomberg expect the ECB to lower rates to 2% in the second half of 2025.
Investors expect the ECB to cut rates to 1.75%
"The market seems to believe that policy needs to move into the easing territory," she said. "From today's perspective, I think this is inappropriate." She also dismissed investors' expectations of a one-time rate cut of 50 basis points, stating she 'strongly leans toward gradualism.'
Bloomberg economists David Powell and Andrej Sokol stated, 'In the last two easing cycles, the ECB ultimately cut rates to about 200 basis points below our estimated neutral rate. Bloomberg Economics believes that for the central bank to have a terminal rate below 2% (our current estimate of the neutral rate) in this easing cycle, a severe shock would be necessary.'
Schnabel warned that despite inflation being below expectations, a rate cut could backfire if underlying economic issues lead to a decline in inflation rates.
Schnabel said: 'In this context, the cost of (moving interest rates) into the easing territory may outweigh the benefits. When future economic shocks arise that monetary policy can respond to more effectively, we will utilize precious policy space.'
Regarding economic growth, she downplayed the unexpected decline in private sector activity this month, citing rising uncertainty from political troubles in Europe and Trump's victory in the U.S. elections. She said this data might exaggerate the extent of economic weakness.
Eurozone private sector activity returns to contraction territory
Schnabel said: 'In light of the actual data, these surveys indicate that the eurozone economy is still stagnating.' However, she added that she currently does not see a risk of recession. 'As far as we know, based on existing data, consumption in the third quarter was stronger than expected. We see some evidence of a consumption-driven recovery in the data. This gives me confidence that this assertion remains credible.'
This view sharply contrasts with the assessment of the outlook by the Governor of the Bank of Italy, Panetta, who urged more focus on the 'slump in the real economy' and stated that interest rates may still have a 'long way to go' from neutrality. He believes policy may need to become expansionary, while others think this discussion is premature.
Schnabel stated that increasing evidence suggests the effects of the ECB's tightening policy are 'clearly fading.' She said a recent survey showed that most banks no longer believe that interest rates are suppressing loan demand, and the real estate sector seems to be bottoming out.
She said that while the neutral rate may be higher than before the COVID-19 pandemic, 'we are in a very different world.'
"Our public debt is much higher, more dispersed, and requires significant investment to meet the challenges we face," she said, "and the artificial intelligence revolution could also enhance our productivity."
As for the inflation rate, Schnabel believes it will reach 2% next year, although price pressures in the service sector remain high. However, she warned against focusing solely on when to achieve the target, stating that the anti-inflation journey in 2025 may still be 'bumpy.'
Eurozone inflation may rise this month
Some officials warned that if interest rates remain high for an extended period, price growth could become overly weak. The Governor of the Bank of France, Villeroy, stated last week that officials will 'closely monitor' such risks.
Schnabel believes this is not a significant risk and expects the ECB's December forecasts to show inflation 'will remain close to the target in the medium term.'
She said that while Trump's return poses another headache for the ECB, there is limited information about what he will actually do, meaning it is too early to draw conclusions now. Schnabel stated that tariffs would jeopardize economic growth, but their impact on prices is less clear, adding that, overall, greater protectionism should produce some inflationary effects.
Article reposted from: Jin Shi Data