‘Limited’ room for smaller rate rises, ECB board member warns

The European Central Bank has “limited” room to raise interest rates in smaller increments because government policies to cushion households and businesses from soaring energy prices will keep euro zone inflation higher for longer, according to a senior policymaker.

Isabel Schnabel, an ECB executive board member, warned that market expectations of a shift to smaller rate rises at its meeting next month had lowered borrowing costs, making it harder to move to a slower pace of monetary tightening.

Signalling her desire to continue with rate rises of 0.75 percentage points, Ms Schnabel told a conference in London that “the largest risk for central banks remains a policy that is falsely calibrated on the assumption of a fast decline in inflation, and hence on an underestimation of inflation persistence”.

Ms Schnabel said the impact of government support measures meant the ECB would have “to raise rates further, probably into restrictive territory”, whereby growth would be constrained, to bring euro zone inflation down from a record level of 10.7 per cent in the year to October and back to its 2 per cent target.

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“Many fiscal measures that are popular among the electorate, such as tight price caps or broad-based subsidies, risk fuelling medium-term inflation further,” she said, adding this “could ultimately force monetary policy to raise interest rates beyond the level that would be seen as appropriate without fiscal stimulus”. – Copyright The Financial Times Limited 2022