ECB’s Schnabel Signals June Rate Hike as Energy Shock Fuels Inflation Risks

European Central Bank board member Isabel Schnabel said the ECB should move forward with an interest rate increase in June, arguing that the prolonged conflict involving Iran and the resulting surge in energy prices have created inflationary pressures that can no longer be ignored, even if peace negotiations ultimately succeed.

The ECB has left interest rates unchanged over the past year, but policymakers seriously discussed the possibility of tightening policy during last month’s meeting after energy costs climbed sharply and inflation moved well above the central bank’s 2 percent target. Several ECB officials have since indicated that additional policy action may soon be necessary.

“Given the size and the persistence of the current shock, looking through is no longer an option in my view,” Schnabel said in an interview with Reuters. “From today’s perspective, I think a rate hike in June will be needed.”

Although the United States has indicated that negotiations aimed at securing peace with Iran are making progress, Schnabel suggested that the economic consequences of the conflict may already be too deeply embedded to avoid monetary tightening. The ECB official, who is considered a possible successor to ECB President Christine Lagarde next year, pointed to lasting disruptions to energy systems and supply chains.

“Even if the war ended today, a lot of damage has already been done to energy infrastructure and global supply chains,” said Schnabel, who previously worked as a 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 added.

Inflation in the euro zone reached 3 percent last month and is expected to continue rising. ECB officials are increasingly concerned that elevated energy prices could spread throughout the broader economy by increasing the cost of goods and services more generally, potentially creating a self-reinforcing inflation cycle that becomes difficult to contain.

According to Schnabel, there are already signs that these so-called second-round effects are beginning to emerge. She cited several indicators, including the ECB’s Consumer Expectations Survey, Purchasing Managers’ Index data, and the European Commission’s sentiment index.

“We are seeing increasing signs that the shock is spilling over to other parts of the consumption basket,” Schnabel said.

Looking beyond June, Schnabel stressed that the ECB should avoid committing itself in advance to any particular policy path. Instead, she said the central bank should evaluate incoming economic data at every meeting before making further decisions.

Still, she noted that the ECB’s own baseline projections currently anticipate two interest rate increases, potentially suggesting that a single hike may not be sufficient to address inflationary pressures.

Financial markets have already fully priced in two increases to the ECB’s 2 percent deposit rate and currently estimate roughly a 50 percent probability of a third hike over the next year. Economists remain somewhat more cautious, however. A Reuters survey found that most analysts expect only two hikes before the ECB eventually begins cutting rates again in mid-2027.

Concerns about economic growth remain one of the primary reasons many ECB observers expect only gradual tightening. The euro zone economy continues to struggle, and analysts fear that persistently high energy costs could have a greater impact on growth than previously anticipated.

Last week, the European Commission forecast economic growth of 0.9 percent for 2026, representing a significant slowdown from the previous year. Even that projection, according to Schnabel, may prove too optimistic.

“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.

Schnabel, who oversees the ECB’s market operations, also commented on recent financial market developments, saying she was not alarmed by volatility in euro zone government bond yields.

“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.”

Asked about her own future at the central bank, Schnabel, whose current ECB term runs until the end of 2027, indicated she would be willing to assume the institution’s top position if called upon to do so.

By fLEXI tEAM