ECB’s Schnabel advocates gradual cuts, flags Trump’s trade risks

Interest rates are nearing neutral territory, ECB’s Isabel Schnabel has said, backing gradual cuts amid persistent inflation. She highlighted risks from Donald Trump’s trade policies, noting potential economic shocks for Europe as tariffs loom over export-heavy economies.

Isabel Schnabel, a member of the European Central Bank’s (ECB) Executive Board, has said there is limited scope for aggressive rate cuts as the bank aims to balance persistent inflation with growing global risks, including the potential economic fallout from renewed US tariffs under Donald Trump.

The ECB is already nearing a neutral interest rate range and cautioned against cutting rates below that level, Schnabel said in an interview with Bloomberg on Wednesday, reflecting her standing as one of the most hawkish members of the bank’s board.

“We’re now getting closer to neutral territory”, she said, estimating the neutral rate at 2% to 3%, and urging a gradual rate path ahead.

Schnabel backs gradual rate cuts, warns against sharp easing

Schnabel described the ECB’s current strategy as “gradual”, with real interest rates near zero and some signs of recovery in interest-sensitive sectors such as housing. Loan demand, too, appears to be stabilising.

Despite this, she pushed back against market expectations of a shift toward accommodative policy, which would involve rates falling below neutral.

“Markets seem to assume that we will need to move into accommodative territory. From today’s perspective, I do not think that would be appropriate”, she said.

Schnabel added that the ECB must preserve its policy space for future shocks, avoiding premature moves that would fail to address the eurozone’s structural investment deficit.

Trump tariffs Pose Risks for Europe

The potential return of US trade tariffs under Trump’s administration has created fresh uncertainty for the euro area.

Schnabel noted that financial markets are already reacting, with the euro weakening against the dollar as investors anticipate stronger US growth.

She highlighted the mixed inflationary effects of trade barriers. “On the one hand, tariffs could be inflationary, in particular if there’s retaliation. Then we would have rising import prices, reinforced by a weaker exchange rate. On the other hand, you could have weaker foreign and domestic demand and a diversion of trade from China to the euro area, which could dampen price pressures,” she said.

Schnabel also said uncertainty over US policy could weigh on investment and consumption. “We know that uncertainty has an impact on consumption and investment,” she said, reflecting concerns that Europe’s export-heavy economies such as Germany remain particularly vulnerable.

Eurozone economy is stagnating

The latest S&P Global Purchasing Managers’ Index (PMI) revealed a grim outlook for eurozone business activity, with November’s reading at 46.5, well below the 50-point threshold separating contraction from expansion. France’s PMI fell sharply to 44.0, while Germany continued to struggle with cyclical and structural challenges.

“The euro area economy is still stagnating”, Schnabel said, noting the interplay of global uncertainty and the region’s structural weaknesses.

“We’re facing a combination of cyclical and structural weaknesses in a very volatile and uncertain global environment.”

Despite this, Schnabel expressed cautious optimism about consumption-led growth.

“Consumption in the third quarter, as far as we can tell on the basis of the available data, was stronger than expected”, she said. “This gives me confidence that this narrative remains plausible.”

Labour markets, while stable overall, are showing signs of divergence. Schnabel noted that unemployment remains low across the eurozone but acknowledged anecdotal evidence of rising job losses, particularly in Germany.

“We’ve seen some heterogeneity across the euro area in terms of growth, and this heterogeneity is also showing up in the labour market”, she said.

Inflation challenges remain

Services inflation is at 4%, unchanged from November last year. Schnabel said that wage growth must decelerate further to achieve the ECB’s 2% inflation target by 2025.

“For a sustainable decline of inflation to our 2% target, we need to see services inflation come down”, she said.

Recent wage negotiations in Germany have been less aggressive, which Schnabel described as encouraging. “This gives me some confidence that wage growth is going to decline in line with our projections”, she said.

Energy and food prices remain potential inflationary risks. “We’ve seen, for example, that gas prices have gone up notably. Food prices have picked up again recently, too. But overall, the disinflationary process is on track”, she said.

Need for flexibility over forward guidance

Schnabel said the ECB would maintain flexibility, avoiding rigid forward guidance. “Given all the uncertainty we are facing, this is not the time for tying our hands through forward guidance”, she said.

“How can I communicate about our destination if I don’t know it myself?” She dismissed speculation about a larger-than-expected rate cut or the need to return to quantitative easing, saying: “I never rule anything out, but I have a strong preference for a gradual approach.”

She said that any future policy decisions would consider the evolving economic outlook, including the risks posed by geopolitical shocks, volatile energy prices, and labour market developments.