European Central Bank Executive Committee leans towards hawkish monetary policy: Interest rate hike in June is a must, even if a peace agreement with Iran is reached it will not stop the tightening.

Isabel Schnabel, a member of the European Central Bank's Executive Board, said that even if a peace agreement with Iran is reached, the ECB should still raise interest rates in June because the conflict has lasted longer than expected and high energy prices are spreading to a wider range of the economy. Over the past year, the ECB has kept interest rates unchanged, but discussed raising them last month due to sharply rising energy costs pushing inflation significantly above the 2% target, and several policymakers signaling the need for action. In an interview, Schnabel said, "Given the scale and persistence of the current shock, in my view, the option to 'ignore' is no longer on the table." "From the current situation, I believe an interest rate hike is necessary in June." Although the US has signaled progress in peace talks with Iran, Schnabel, a potential successor to ECB President Lagarde, said the ECB may have reached a point of no return as energy infrastructure has been damaged and high energy prices are spreading to a wider range of the economy. Peace agreement is unlikely to prevent rate hikes "Even if the war were to end today, energy infrastructure and global supply chains have already suffered significant damage," said Schnabel, a former university professor. "Therefore, even in that scenario, I think a monetary policy response is necessary." "We have actually exceeded the adverse scenario where oil prices would quickly return to normalcy in terms of persistence," she said. Inflation reached 3% last month and could further rise. Policymakers are concerned that high energy costs will push up prices of other goods and services through second-round effects, triggering uncontrollable inflation. Schnabel said that, as shown by various surveys including the ECB's Consumer Expectations Survey, PMI data, and the EU Commission's sentiment indicators, some of these second-round effects may already be materializing. She added, "We see more and more signs that this shock is spreading to other parts of the consumption basket." After June, Schnabel said that the ECB should not commit to any policy steps but should reassess its stance at each meeting based on data. However, she noted that the ECB's core forecast includes two rate hikes, implying that a single hike may not be enough. Financial markets have fully priced in expectations of two rate hikes by the ECB's 2% deposit rate and see a 50% chance of a third action in the next year. A Reuters survey shows economists are more cautious, expecting only two rate hikes followed by a cut in mid-2027. Economic growth appears sluggish One key reason why observers believe future policy tightening will be modest is that the Eurozone economy remains weak, and the suppression of economic expansion by high energy costs may be more severe than feared. The EU Commission predicted last week that economic growth in 2026 would be 0.9%, a significant slowdown from last year, and this forecast may still be too optimistic. "Schnabel said, "Given the high persistence of this shock, I believe the negative impact on economic growth will be stronger." "We have seen a sharp decline in confidence indicators, especially among consumers." "All of this suggests that economic growth faces downside risks while inflation faces upside risks," she added. Schnabel, who is responsible for market operations at the ECB, said that financial markets are coping well with these developments and recent fluctuations in government bond yields are not concerning. "The rise in Eurozone bond yields is mainly driven by the increase in inflation compensation," she said. "This partly reflects rising inflation risk premiums due to increased uncertainty about future inflation prospects." As for her future, Schnabel (whose term at the ECB ends in late 2027) said that if invited, she would be ready to take on the role of President.