I. Schnabel: The ECB must react dynamically to the inflationary impulse

In the opinion of the director of the central bank Isabel Schnabel, the European Central Bank (ECB) must react dynamically to the rise of inflation in the eurozone. Both the likelihood and the cost of today’s high rate of inflation being embedded in expectations are uncomfortably high, he told a Federal Reserve symposium in Jackson Hole, Wyoming, yesterday.

“In this environment, central banks must act strongly,” said the German economist. They must act decisively against the risk that people will start to doubt the long-term stability of their currencies, he said.

“The longer inflation remains high, the greater the risk that the public will lose confidence in our resolve and ability to maintain purchasing power,” Schnabel said. If a central bank underestimates the persistence of inflation – which most central banks have done over the past year and a half – and is slow to change its monetary policy, the resulting costs could be significant, he warned.

The ECB had launched the rate hike at its July meeting, raising key rates by 0.50 percentage points, contrary to what it had previously promised. It was the first rate hike in eleven years. The prime rate is now 0.50%.

The ECB’s next interest rate meeting is on September 8. Stock markets are currently expecting another rate hike of half a percentage point. However, some euro watchers, given the poor outlook for inflation, have meanwhile argued that an even bigger increase of 0.75 percentage points should be discussed at the September meeting.

In her speech, Ms. Schnabel also warned of the risk of entrenching the perception that the central bank has now become more tolerant of high inflation rates. “Decisive action is needed to overcome these perceptions,” the ECB chief said. If uncertainty about the central bank’s reaction undermines confidence in its commitment to ensure price stability, a cautious approach to monetary policy is no longer appropriate, he said. “To recover and maintain confidence, we must quickly return inflation to target.”

Eurozone inflation rose to a new record high of 8.9% in July. That means inflation is now more than four times the euro central bank’s target of two percent over the medium term. Consumers have recently been rather pessimistic about the further development of inflation. In a survey conducted by the ECB in June, consumers assumed that inflation would still be at 5.0% in twelve months.