Schnabel: ECB Should Exercise Caution in Bond Purchases and Guidance

Forex - ECB Governing Council member Isabel Schnabel stated that interest rate changes will remain the primary policy tool of the European Central Bank, along with forward guidance on bond purchases. Schnabel noted that just months before announcing a strategic review examining how the bank uses its instruments, this market distortion was the reason for changing the ECB's approach to bond purchases in a process commonly known as quantitative easing.

"In this environment, central banks need to prioritize agility and flexibility to effectively manage inflation. Therefore, short-term interest rates continue to be the preferred tool in most cases," Schnabel remarked. She also pointed out that interest rates can be swiftly altered and that years of negative rates were reversed in a single meeting when inflation began to rise in mid-2022.

Schnabel assessed, "Since bond assets can only be unwound gradually, asset prices will remain distorted for a prolonged period. This means that the threshold for initiating QE should be higher compared to the past." She argued that bond purchases are effective in alleviating short-term market stress, stating, "Asset purchases are a powerful tool for stabilizing financial markets during periods of stress." Schnabel added, "Stabilizing financial markets typically only requires short-term interventions."

Furthermore, she claimed that forward guidance, a popular tool used during periods of very low interest rates, is problematic because it constrains banks and contributed to a relatively slow initial response to rising inflation at the end of 2021 and the beginning of 2022. Schnabel concluded, "In today's volatile environment, forward guidance therefore has limited utility for central banks."