Source: European Central Bank
Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by David Barwick and Marta Vilar on 9 July 2025
11 July 2025
Ms Schnabel, abstracting from the still-open question of tariffs, would you say that developments since 5 June support the idea that the ECB is in a good place, weakening the case for another move?
Yes, we are in a good place. Disinflation is proceeding broadly as expected, even if services inflation and food inflation remain somewhat elevated. We are now close to having successfully tackled past inflation shocks, which is good news. Over the medium term, inflation is projected to be at 2% and inflation expectations are well anchored. In view of this, our interest rates are also in a good place, and the bar for another rate cut is very high.
Let me explain. First, I see no risk of a sustained undershooting of inflation over the medium term. Core inflation is projected to be at target over the entire projection horizon. The low energy price inflation is likely to be temporary, and the fear of the exchange rate appreciation putting downward pressure on underlying inflation is exaggerated in my view, as the pass-through is likely to be limited. In fact, this appreciation also reflects the new growth narrative in Europe, meaning there is a positive confidence effect, which attracts capital and lowers financing costs.
Second, the economy is proving resilient. Economic growth in the first quarter of 2025 was better than expected. Sentiment indicators have also surprised to the upside – the composite Purchasing Managers’ Index rose again in June. And it’s noteworthy that manufacturing has continued to improve, with, strikingly, all the forward-looking indicators having continued their upward trend – new orders, new export orders, future output are all at three-year highs. This suggests that we’re seeing more than just frontloading. Moreover, the labour market remains resilient, with unemployment at a record low and employment continuing to grow. It seems that the uncertainty is weighing less on economic activity than we thought, and on top of that, we’re expecting a large fiscal impulse that will further support the economy. So overall, the risks to the growth outlook in the euro area are now more balanced.
It sounds like you see no grounds for the ECB to seriously consider further easing, even if it were to wait before moving again.
There would only be a case for another rate cut if we saw signs of a material deviation of inflation from our target over the medium term. And at the moment, I see no signs of that.
Is the potential cost of an unnecessary cut high enough to outweigh risk management arguments for a so-called insurance cut?
I don’t think that risk management considerations can justify another rate cut. Domestic inflation is still elevated and inflation expectations of households and firms are tilted to the upside. Additionally, a more fragmented global economy and a large fiscal impulse pose upside risks to the inflation outlook over the medium term. Therefore, from today’s perspective, a further rate cut is not appropriate.
I would also warn against fine-tuning monetary policy to incoming data. For example, it would be risky to base a monetary policy decision solely on the evolution of energy prices, because we’ve seen oil prices fluctuate between USD 60 and almost USD 80 since March alone. We should remain firmly focused on the medium term and on core inflation. This is also in line with our updated monetary policy strategy, which says that we need to be agile to recognise fundamental changes in the inflation environment, but that we can tolerate moderate deviations from target if there’s no risk of a de-anchoring of inflation expectations.
We don’t yet know the final tariff outcome, but observers expect Europe to get away with a general 10%, along with individual tariffs on certain sectors and some exceptions for others. If you share this view, what impact on growth and inflation do you expect?
Indeed, it looks like tariff negotiations are moving towards our baseline scenario. But of course, there remains uncertainty about the outcome of the negotiations. Tariffs have a dampening effect on economic activity in the short run. However, if the negotiations are concluded successfully, this will lower uncertainty, which would support consumption and investment.
As regards inflation, I see a net inflationary effect over the medium term, because the dampening effect from a weaker global economy and potential trade diversion is likely to be offset – or even overcompensated – by supply-side effects, which are not included in our standard projection models. This includes cost-push shocks rippling through global value chains, supply chain disruptions and the loss of efficiency from a more fragmented world.
You said the bar for another rate cut is very high. Is that because we’re approaching accommodative territory? Or are we already in it?
I think we are becoming accommodative. If you look at the latest bank lending survey, you see 56% of banks reporting that interest rates are boosting the demand for mortgages, while only 8% say they’re holding demand back. Moreover, the natural rate of interest may have increased recently due to the historic shift in German fiscal policy. This is also reflected in financial markets, where real forward rates have moved up, which reflects the expected higher demand for capital, including from the private sector. That means that, for a given level of the policy rate, our policy becomes more accommodative. And this is what’s also reflected in the pick-up in bank lending.
What other indicators do you rely on to gauge your level of accommodation?
We look at general economic developments, which also reflect the restrictiveness of our monetary policy. And as I said, the economy has proven more resilient than we had thought.
You described the pass-through of the EUR/USD exchange rate as limited. Can you be more specific? Is there a point at which this suddenly changes?
I find the debate about the exchange rate appreciation exaggerated. I do not remember people having a similar concern when the exchange rate was moving towards parity in early 2025. And this did not prevent us from cutting rates further. If you take a longer perspective and look at the past two decades, we’ve had comparable or even larger appreciations with a rather limited impact on inflation.
There are reasons to believe that the pass-through may be limited this time as well, especially to underlying inflation. First, the source of the shock matters. In this case, the stronger exchange rate is also a reflection of a positive confidence effect and investors’ belief that the euro area’s growth potential may be higher than thought. Moreover, you see a rebalancing of investors into the euro area, which tends to lower financing costs, counteracting the tightening effect of the exchange rate.
Second, more than half of our imports are invoiced in euro, which reduces the pass-through. Firms may also use the occasion of lower import costs to protect their profit margins rather than pass these lower costs on to consumers.
Finally, the impact of the exchange rate on competitiveness and foreign demand is mitigated by the high import content of our exports.
But to get back to your second question, we do not target the exchange rate and we do not respond to any particular exchange rate level. Exchange rates enter our projection models via the assumptions, and we know that they can change in either direction at any point.
So further appreciation is manageable indefinitely, as long as it remains reasonably gradual?
We always have to monitor what is happening. I don’t like to make very general statements about what could happen. At the moment, it’s manageable.
You recently said that the estimate of the impact of higher fiscal spending incorporated into the projections is “relatively conservative”. What’s being underappreciated? Is it the timing? The composition of the spending?
I see several aspects. The first is indeed timing. We’ve been positively surprised by the frontloading of spending plans by the German government. It seems they’re determined to deliver on their promises. The second aspect is fiscal multipliers. They could be higher than assumed depending on how the money is spent. Generally, they tend to be higher when the money is spent for investment. And the details of defence expenditures also matter: what share is going to be sourced domestically, and what share is used for R&D-related expenditures? A third, very important point is that our models may not fully capture the complementarity between public and private investment – that is, that private investment is being crowded in by public investment. Just recently, a group of large German corporations announced that they are planning a large investment programme, which would amplify the positive effect of public spending.
How much potential do you see for a stronger-than-anticipated fiscal impulse to alter the inflation outlook and thus your policy calibration in the second half of this year?
The fiscal measures are going to play out mainly over the medium term, not the short term. But inflation could eventually pick up if the economy hits capacity constraints, also due to demographic developments, which will accelerate over the coming years.
Your remarks seem to confirm that the ECB is not unhappy about the fact that the US dollar has been weak. Do you see a risk that the public discussion could provoke a US reaction the ECB needs to worry about?
The current situation risks undermining the exorbitant privilege of the US dollar, a privilege the United States has enjoyed over many decades, which has led to lower financing costs for American households, firms and the government. This offers a historical chance for the euro area to foster the international role of the euro as a global reserve, invoicing and funding currency, to reap some of those benefits. But there are three important prerequisites. The first is a revival of euro area growth. The second is safeguarding the rule of law and security, including in military terms. And the third is a large and liquid EU bond market.
On the savings and investment union, how can the ECB – while staying within its mandate – play a stronger role in highlighting how structural inefficiencies in cross-border capital flows impede monetary policy transmission and private risk sharing?
We’ve been very vocal about the savings and investment union. The President has given several speeches and the Governing Council has issued its own communication on the topic. This is because integration is closely related to our mandate. Our monetary policy is more effective in an integrated market. Integration improves monetary policy transmission by increasing private risk sharing and fostering convergence. This is firmly within our mandate. But let me also stress that the savings and investment union is about more than financial integration. It’s about fostering innovation and economic growth. This concerns not just the availability of capital, especially risk capital, but also the possibility for firms to scale up within the Single Market. We know that the internal hurdles within the Single Market are very high – some estimates show they’re much higher than the tariffs that we may be facing from the United States. So, one important part of the savings and investment union is to reduce these barriers within the Single Market. I think the 28th regime for innovative companies is a very promising proposal to allow those companies to scale up easily all over Europe. The ECB can only inform the debate through speeches and analysis, but in the end, progress will depend on the political will of governments.
Back to the United States, where Donald Trump is calling daily on Federal Reserve Chair Jerome Powell to resign. In the past 24 hours, we’ve had new speculation about who the next Fed Chair might be. Even if Powell stays to the end of his term, there could be an announcement long before that, and his intended successor may start to make public pronouncements about his intentions that lead to market repricing and an even stronger euro. Does this worry you – and more broadly, are you concerned about any other changes that could disadvantage Europe if a more “Trumpy” Fed Chair emerges?
The current discussion is testimony to the importance of central bank independence, and the Federal Reserve is leading by example. It’s very dangerous when you have direct interference by governments in monetary policy, because this can destroy the trust that has been built over decades. One concrete advantage of independence is that it reduces risk premia. By challenging Fed independence, risk premia may move up, which would increase rather than lower interest rates. Overall, I would never underestimate the institutional resilience of the Fed, so I remain optimistic.
Does this optimism also reflect the fact that you just had the opportunity to speak with Chair Powell at the ECB Forum on Central Banking in Sintra, Portugal?
Absolutely.
As excess liquidity continues to decline, are you observing any emerging signs of segmentation, whether across jurisdictions or across bank tiers, in the transmission of short-term interest rates?
There are no signs of segmentation. In fact, with quantitative tightening (QT) proceeding, market functioning has improved because collateral scarcity has gone down. Our new operational framework can deal very well with the heterogeneity across the euro area. Any bank can access our operations at any time, at the same rate, for the amount that they need, based on a broad set of eligible collateral. So far, the banks’ recourse to our operations has been rather limited because excess liquidity is still abundant, and that is also reflected in market funding being more favourable than our operations. Over time, excess liquidity is going to go down, and eventually the situation will change and more and more banks will access our operations. We are observing that process very carefully.
Even if market function still appears smooth, are there any early indicators you’re watching especially closely?
We are closely monitoring the functioning of money markets, and we have a whole range of indicators for that, but at the moment, we don’t have any concerns.
On a related subject, as balance sheet reduction continues, do you see any risk that at some point it could impair monetary policy transmission or disrupt market functioning?
Not at all. It’s important to understand the functioning of our operational framework, which is designed in a way that ensures smooth monetary policy transmission. In line with our decision, the monetary policy bond portfolios under the asset purchase programme (APP) and the pandemic emergency purchase programme (PEPP) are going to be run down to zero. At some point, once the ECB balance sheet is growing again, we will provide a significant part of banks’ structural liquidity needs via structural operations, namely longer-term lending operations and a structural bond portfolio. But these are distinct from quantitative easing (QE), which remains a tool for exceptional circumstances that is going to be used more sparingly in the future.
With sovereign spreads generally contained for now, do you view the current pace of the APP rundown as appropriate?
Yes. It’s running smoothly in the background and our experience with our gradual and predictable approach has been very positive.
What could trigger a change in the pace?
To change the pace of QT, you would need to have a monetary policy argument. And we said that our unconventional tools are to be used when we are near the effective lower bound, based on a comprehensive cost-benefit analysis. This is not our situation today. Hence, the plan is to run down the monetary policy bond portfolios to zero. The provision of liquidity for the implementation of our monetary policy won’t be done via QE – which is a stance instrument – but rather via our weekly lending operations and, at a later stage, the structural operations, once excess liquidity has declined to the point where demand for additional central bank liquidity begins to rise.
The time lag between the cut-off date for the technical assumptions and the publication of the projections is quite long, and in this volatile world it seems that this delay could compromise the reliability of the projections. Is this approach still justified?
This lag is mainly due to organisational reasons, especially when we are running the projection exercise together with the entire Eurosystem. There is a huge machinery to be managed, with many people to be coordinated, and the outcome then has to be incorporated into the material sent to the Governing Council. The timelines are already very tight. But more fundamentally, your question reveals a common misunderstanding about our projections. In the strategy assessment, we stressed the importance of the uncertainty surrounding our baseline projections. This uncertainty stems from the assumptions, and it also comes from more fundamental uncertainty, like the outcome of tariff negotiations. But it’s a mistake to focus only on the point estimates. What the projections give you is not just this number – which is almost certainly wrong and may change from day to day – but a range of plausible outcomes. This range is what we should focus on, because the point estimates alone may be misleading if you do not also consider the uncertainty.
To what extent is the return to 2% inflation in 2027 contingent on regulatory measures like the EU’s new emissions trading system ETS2, and does this raise credibility risks if those inputs prove unreliable?
In general, projecting energy prices is complicated. We are using futures prices in our staff projections even though they are not necessarily a good predictor of energy prices. Here we have an additional complication in that the new ETS has its own uncertainties, such as when it will come and how large its effects are going to be. And this brings me back to the point that we should focus on core inflation, acknowledging that whatever happens with respect to energy – as we’ve seen in the recent inflation surge – may feed into core inflation, especially when prices rise.
In concluding the strategy assessment, the ECB committed to act forcefully or persistently in response to large, sustained inflation deviations. What criteria would lead you to conclude that it’s appropriate to act forcefully or persistently?
The strategy assessment implies that we can tolerate moderate deviations from our inflation target as long as inflation expectations are firmly anchored. But when we see a risk of a sustained deviation from the target in either direction that could de-anchor inflation expectations, we will act appropriately forcefully or persistently, depending on the situation at hand and based on a comprehensive cost-benefit analysis. What this means is that first, we have to be agile in order to detect a fundamental shift in the inflation environment. We were lacking this agility at the time of the recent inflation surge, as it took us some time to recognise that we had shifted very quickly from a low-inflation environment to a high-inflation one. We want to be more agile to be able to react to such a change more rapidly. Second, we have to pay a lot of attention to inflation expectations – not just market-based inflation expectations, because these may be subject to a “monkey-in-the-mirror” problem and may merely reflect our own thinking. It’s important to look at a broad set of indicators, including household and firm inflation expectations. And in fact, if you look at the Consumer Expectations Survey, you see that household inflation expectations reacted relatively early to the change in the inflation environment. So, this can give us useful signals.
And the word “sustained” means extending into the medium term?
I’m always talking about the medium term, as this is what matters for our monetary policy. But sustained means that it’s not just temporary, and we all know that it’s difficult to judge whether something is temporary or not, but we will have to deal with that in the future.
In the wake of the strategy assessment, does anything change about the weights you attach to model-based outputs, your judgement or real-time indicators?
What I think is changing is our approach to data dependence. Over the past few years, data dependence played a very important role: the incoming data served as a cross-check to verify whether the data were in line with the projected decline in inflation over time. This allowed us to cut interest rates at a time when domestic inflation was still elevated. Now we’ve entered a new phase in which we are using incoming data to assess whether there could be a sustained deviation of inflation from target over the medium term. Scenario analysis helps us to navigate the uncertainty that we are facing, and the incoming data can tell us which scenario is most likely to materialise. Of course, projection models have their shortcomings, and we have to continuously improve the models, as we’ve done over recent years. For example, in our analysis of the impact of tariffs on economic activity, trade policy uncertainty played a very important role, but now we’re seeing that the economy is more resilient than we expected. This could be an indication that the impact of trade policy uncertainty is smaller than thought. Another example is the modelling of the supply-side effects of tariffs, which are currently not in our projection models.
How do you evaluate the prospects for Germany to emerge from the economic doldrums?
Germany has been facing severe structural weaknesses and a loss in competitiveness. To escape stagnation, it will have to implement growth-enhancing policies. The fiscal package is one important ingredient. But just spending money will not be enough. First, you have to make sure that the money is spent wisely, meaning on investment, not consumption. Second, the spending has to be accompanied by comprehensive structural reforms, including of the social security system, especially given demographic developments. We see a clear turnaround in sentiment in the German economy. But now the German government has to deliver. I see a chance to escape low growth, and this chance should not be wasted.
So, you share the optimism expressed by Bundesbank President Joachim Nagel earlier this week?
Yes, I’m also optimistic.
And with regard to the change in the German attitude towards fiscal spending, what do you think the implications are for euro area growth and inflation?
Germany is in a situation in which it can expand its government spending, because it has fiscal space. If done properly, this can help increase potential growth, which would also have positive spillovers to the rest of the euro area. This may go along with higher interest rate costs, but if potential growth increases at the same time, this is manageable.
Traditionally, we’ve had the core, rather fiscally conservative countries of the euro area on the one hand, and the more fiscally relaxed periphery countries on the other. Do you see this division being blurred as a consequence of the new German fiscal attitude?
Germany is in a very different position from countries like France and Italy. Those countries are facing much more difficult decisions. When they want to increase defence spending as foreseen, they will have to reduce their spending elsewhere, which is politically very demanding. So, I think the difference in the fiscal situations is still there.
When you speak publicly, how do you balance your own preferences and own views with the need to represent the ECB and its institutional interests?
One always has to strike the right balance, but I believe that the transparency about the diversity of views within the Governing Council is a feature, not a bug. It enhances our credibility. It also helps market participants better understand the discussions in the Governing Council and detect certain shifts in policies before the decision has been taken. That ultimately helps the transmission of our monetary policy. I have always been loyal to our collegial decisions, and I try to explain their rationale in public. But of course, when I see important new narratives that are relevant for the monetary policy discussion, I express my views. I explain them in comprehensive speeches based on empirical analysis, and I hope that that helps the debate.