ECB's Schnabel: More Hikes Ahead as Eurozone Defies Slowdown Fears

Eurozone Resilience Bolsters Case for ECB's Schnabel to Push for Further Hikes

European Central Bank (ECB) board member Isabel Schnabel has signaled that interest rates must rise further, pointing to the eurozone economy's surprising resilience in the face of aggressive monetary tightening. Speaking at a recent event, Schnabel noted that the economy has so far weathered the fastest rate-hiking cycle in the ECB's history better than many had feared, which in turn keeps inflation pressures alive.

The ECB has already lifted its deposit rate from -0.5% to 3.5% since July 2022, yet Schnabel's comments suggest policymakers see room for more. She argued that the strength of the labor market, still-elevated core inflation, and the gradual pass-through of past rate hikes into the real economy all support a continued normalization of policy.

Her remarks come ahead of the ECB's next meeting in September, where markets currently price in roughly a 60% chance of a 25-basis-point hike. Schnabel's hawkish tone may reinforce that expectation, though the final decision will depend on incoming data, particularly the next round of inflation and growth figures.

What's Driving Schnabel's Hawkish Stance? Inside the ECB's Inflation and Growth Calculus

Persistent Core Inflation Keeps Pressure on the ECB

Core inflation in the eurozone, which strips out volatile food and energy prices, has been stickier than headline inflation. While headline inflation fell to 5.5% in June from a peak of 10.6% last October, core inflation has only eased from its 5.7% high to 5.5%. Schnabel emphasized that this persistence is a key reason why the ECB cannot afford to pause its tightening cycle prematurely.

She also cautioned against reading too much into the recent decline in headline inflation, as energy base effects are set to fade. With wage growth accelerating and profit margins absorbing some cost pressures, the risk of a wage-price spiral remains, in her view.

Resilient Economy Reduces Recession Risk, but Not Inflation

The eurozone economy has dodged a recession so far, with first-quarter GDP growth of 0.1% and a second quarter that appears to have expanded modestly. The labor market remains robust, with the unemployment rate at a record low of 6.5%. Schnabel argued that this resilience gives the ECB room to continue hiking without fearing an immediate economic collapse.

However, she acknowledged that the full impact of past rate hikes is still working its way through the economy. The ECB's own analysis suggests that the peak effect on growth and inflation may not be felt until 2024, meaning the central bank must look beyond the current data to avoid overtightening.

Key Levels to Watch: Euro, Bund Yields, and Rate Expectations

Traders should keep a close eye on the euro exchange rate, which tends to react sharply to shifts in ECB rate expectations. A hawkish Schnabel has historically supported the euro, but the currency's fate also hinges on the Federal Reserve's policy path. A widening rate differential in favor of the euro could push EUR/USD toward the 1.10 handle, while a dovish surprise from the ECB could send it back below 1.08.

German Bund yields, the benchmark for eurozone borrowing costs, are another key indicator. The 10-year Bund yield has already risen to around 2.5%, and further hikes could push it toward 2.7%. For technical analysis, traders often use moving averages and RSI to gauge momentum in these markets. Additionally, the euro price is directly influenced by these rate expectations.

What This Means for Traders: Positioning for a Higher Terminal Rate

For traders, Schnabel's comments reinforce the narrative that the ECB is not done yet. This has implications for short-term interest rate futures, which are pricing a peak rate of around 3.75% by early 2024. If the ECB delivers more hikes, those expectations will need to move higher, potentially boosting the euro and pressuring eurozone equities.

However, there are risks to this view. If the economy shows signs of cracking under the weight of higher rates, the ECB could be forced to reverse course quickly. The lag effect of monetary policy is notoriously unpredictable, and the ECB's own staff projections see growth slowing to just 0.9% this year and 1.5% in 2024.

Traders should also consider the broader global context. The Fed's next decision, due in September, will influence risk sentiment across all markets. A hawkish Fed would likely strengthen the dollar, offsetting some of the euro's gains from ECB hawkishness. As always, it's wise to stay flexible and use community trade ideas to gauge market sentiment.

For those new to trading, understanding how central bank policies drive currency movements is a fundamental skill. Our classroom offers a structured path to build that knowledge, and you can also take a quick quiz to identify your trading style. To act on these insights, you'll need a reliable broker account.