ECB should watch out for price hikes from U.S. tariffs, Schnabel says

ECB policymaker Isabel Schnabel, while acknowledging progress in taming inflation to below 2%, cautioned that new U.S. tariffs could trigger fresh price hikes. Schnabel cited research indicating that a 1% increase in global producer prices could lead to a 0.2% increase in domestic producer prices, highlighting the potential inflationary impact of trade tensions even without retaliation. She anticipates trade conflicts acting as a global shock, limiting the scope for monetary policy divergence between the ECB and the Federal Reserve.

Analysis

ECB policymaker Isabel Schnabel acknowledged significant progress in curbing Eurozone inflation, with recent figures falling below the 2% target due largely to energy price declines and a downward trend in more persistent components. This progress follows the ECB's decision on Thursday to cut interest rates for the eighth time in the past year and signal a potential policy pause. Despite this, Schnabel, a prominent hawk, cautioned that the focus should shift to new inflationary shocks, particularly U.S. tariffs. She cited research indicating a 1% global producer price increase could lift domestic producer prices by 0.2%, and warned that tariffs would likely be inflationary even without retaliation, referencing China's rare earth export restrictions as an example of trade-related disruptions. Schnabel anticipates such trade conflicts will act as a global shock, impacting both demand and supply, thereby constraining the scope for monetary policy divergence between the ECB and the U.S. Federal Reserve. This view, supported by ECB research showing small effects from trade diversion of Chinese goods to Europe, contrasts with Bank of England policymaker Megan Greene's expectation that trade fragmentation could lower UK inflation and enable BoE policy divergence.

Key Decisions for Investors

• Investors should closely monitor developments in U.S. trade policy and potential international retaliatory measures, as these pose a significant upside risk to Eurozone inflation forecasts and could alter the ECB's policy trajectory.
• Given the highlighted risk of renewed inflationary pressures from tariffs, positions in rate-sensitive assets and inflation-linked securities warrant careful consideration, as the ECB's capacity for further easing could be constrained.
• Portfolio strategies based on significant monetary policy divergence between the ECB and the Federal Reserve should be re-evaluated, as Schnabel's analysis suggests global trade shocks may foster greater policy convergence, potentially impacting currency and bond markets.