The European Central Bank's most hawkish executive warns: further rate cut space is limited, excessive easing will waste precious policy space

According to the Zhitong Finance APP, Isabel Schnabel, a member of the European Central Bank's Executive Board, stated that the ECB needs to be cautious about excessive interest rate cuts, as borrowing costs are already close to a level that can no longer suppress the economy, and further cuts may be counterproductive.

In an interview, Schnabel mentioned that officials could continue to ease monetary policy, but should do so gradually to avoid rates falling below the so-called neutral threshold. This hawkish policymaker warned that excessive easing could waste valuable policy space.

Schnabel stated in the Frankfurt office: "Given the inflation outlook, I believe that if the upcoming data continues to confirm our baseline expectations, we can gradually move towards neutrality. I would caution against going too far, as that would enter the realm of easing."

She estimated the "neutral interest rate," which cannot be precisely measured, to be between 2% and 3%, higher than the levels suggested by dovish officials such as Yannis Stournaras, the Governor of the Bank of Greece, and Mario Centeno, the Governor of the Bank of Portugal. So far this year, after three cuts of 25 basis points, the deposit rate remains at 3.25%, and Schnabel stated, "We may not be far from this level now."

Following Schnabel's comments, the money market reduced bets on ECB rate cuts, expecting only a 146 basis point cut by the end of 2025, down from a previous expectation of 150 basis points. The euro continued to rise, briefly reaching an intraday high of 1 euro to 1.054 US dollars, and the yield on German two-year bonds recovered earlier losses.

These remarks have sparked an escalating debate on how the ECB should respond to the deteriorating eurozone economy, while inflation is approaching the 2% target at a faster pace than previously expected.

Discussions around the pace of easing are becoming increasingly intense, with rising global uncertainties—especially the potential trade tariffs that could come with Trump's return to the White House—complicating the conversation.

Investors expect rates to drop to around 1.75% next year, and Schnabel acknowledged that this is inconsistent with her own assessment. Economists surveyed expect this rate to fall to 2% by the second half of 2025.

She stated: "The market seems to believe we need to enter the easing zone. From today's perspective, I think this is inappropriate." She also dismissed investor speculation about a 50 basis point cut, stating that she "strongly favors a gradual approach."

Bloomberg Economics economists David Powell and Andrej Sokol noted: "In the last two easing cycles, the ECB ultimately lowered rates to about 200 basis points below our estimated neutral rate. Bloomberg Economics believes that going below 2% (our current estimate of the neutral rate) would require a severe shock Schnabel also warned that even if inflation rates are lower than expected, interest rate cuts could backfire if underlying economic issues lead to a decline in inflation.

She stated, "In this case, the costs of entering an easing phase may outweigh the benefits. When the economy faces shocks that monetary policy can respond to more effectively in the future, we will utilize our valuable policy space."

Regarding economic growth, she downplayed the unexpected decline in private sector activity this month, citing European political issues and increased uncertainty from Trump's victory in the U.S. elections. She noted that these figures may exaggerate the extent of the weakness.

Schnabel stated, "Looking at the actual data, these surveys show that the eurozone economy is still in a state of stagnation." She added that she currently does not see a risk of recession. "Based on the existing data, as far as we know, consumption in the third quarter was stronger than expected. We see some evidence of a consumption-driven recovery in the data. This makes me believe that this assertion remains reasonable."

This view sharply contrasts with the assessment of the economic outlook by Italian central bank governor Fabio Panetta last week, who urged more focus on "the weakness of the real economy" and stated that interest rates may have a long way to go before reaching neutral levels. He believes that policy may need to become more expansionary, even if others think such statements are premature.

Schnabel indicated that there is increasing evidence that the impact of the European Central Bank's tightening policy is "clearly diminishing." She mentioned that a recent survey showed that most banks no longer believe that interest rates will suppress loan demand, and the real estate sector seems to be bottoming out.

Schnabel stated that while the neutral interest rate may be higher than before the pandemic, "we are also in a very different world."

She pointed out, "Our public debt is much higher, more dispersed, and requires significant investment to address the challenges we face. The AI revolution may also enhance productivity."

Regarding inflation, Schnabel is confident that it will reach 2% next year—despite the continued high price pressures in the service sector. However, she warned against focusing solely on when the target will be achieved, stating that the path to 2025 may still be "bumpy."

Some officials have warned that if interest rates remain high for an extended period, price growth could become excessively weak. French central bank governor Francois Villeroy de Galhau stated last week that officials will "closely monitor" such risks However, Schnabel believes this is not a significant risk and expects the European Central Bank's December forecast to show that inflation remains "close to our medium-term target."

She stated that while Trump's presidency is another headache for the European Central Bank, there is limited information on what he will actually do, which means it is too early to draw conclusions. Schnabel noted that tariffs will jeopardize economic growth, but the impact on prices remains unclear, adding that, overall, greater protectionism should produce some inflationary effects