European Central Bank (ECB) Executive Board member Isabel Schnabel said on Tuesday that the ongoing conflict in the Middle East, persistently high energy costs, and surprisingly strong Eurozone economic performance mean upside risks to inflation remain significant. She argued that the current policy rate level is insufficient to bring price growth back to the 2% target over the medium term, making further monetary tightening necessary.
In an interview, Schnabel noted that high energy costs could keep Eurozone consumer price growth above 2% for "a prolonged period." She warned that if policymakers wait until price increases feed through to wage levels before acting, they would be "behind the curve." She said: "At the current level of policy rates, inflation is unlikely to return to target over the medium term, so further tightening of monetary policy is necessary. Particularly in the current environment of robust aggregate demand, preventing second-round effects early is crucial, because acting too late could require more aggressive tightening."
Eurozone economic data has continued to deliver upside surprises. Data released on Tuesday showed German second-quarter output growth was stronger than initially estimated, and the Eurozone economy grew 0.4% in the second quarter after stagnating in early 2026—the fastest pace in more than a year. Schnabel attributed the momentum to fiscal policy, a rebound in defense spending, and the global artificial intelligence boom. She said: "Sentiment indicators suggest that economic growth is gaining further momentum. Therefore, compared with the June staff projections, I see risks to economic growth as slightly tilted to the upside."
Inflation data is equally concerning. Eurozone inflation rose to 2.9% in July, and Schnabel specifically noted that energy price pressures beyond oil are becoming more persistent. She said that with European gas storage levels at low levels, the trajectory of natural gas is "particularly worrying," posing a material upside risk to inflation. She said: "The longer the conflict persists, the higher the risk and intensity of indirect and second-round effects, especially when aggregate demand remains strong."
The European Central Bank was the first major central bank globally to raise borrowing costs in response to the Iran War, and officials have designated next month's meeting as a key juncture for determining whether more action is needed. Market investors have almost fully priced in a 25-basis-point hike, which would bring the deposit rate to 2.5%, with another hike possible by spring 2027—potentially as early as December. Schnabel said markets "seem to understand our reaction function very well," but she did not specify how much further borrowing costs might rise, emphasizing only that "how much further tightening is needed will depend on incoming data."
A key point of debate is whether rates need to rise to levels that restrain economic activity. ECB Chief Economist Philip Lane has indicated that 2.5% represents the upper bound of the range where borrowing costs currently exert a neutral impact. This means that if the ECB hikes to 2.5% in September, its policy stance would formally enter restrictive territory, with more pronounced effects on economic growth and the labor market.
Tightening expectations across major global central banks are rising in tandem. Market reports indicate that a Reuters survey of economists conducted from the 17th to the 24th of this month showed 57% of respondents expect the Bank of Japan (BOJ) to raise its benchmark rate in September, up sharply from just 5% last month. The BOJ already raised its benchmark rate to 1% in June—the highest level in 31 years—but inflationary pressure from the Iran War and yen weakness have continued to fuel calls for further hikes. Some experts even expect the BOJ could raise rates again in October or December, pushing the year-end rate to 1.5%.
In the United States, data released by the Federal Reserve showed that the boards of four regional Federal Reserve banks—Dallas, Cleveland, Minneapolis, and Kansas City—all recommended in July that the discount rate be raised by 25 basis points. While regional Fed bank directors are not voting members of the Federal Open Market Committee (FOMC), the move signals that inflation concerns remain widespread within the U.S. central bank system.
Note: The ECB's current deposit rate is 2.25%, and markets broadly expect the September meeting to deliver a hike to 2.5%.
Schnabel's hawkish remarks come as discussions within the ECB about the terminal rate level intensify. The 2.5% upper bound of the neutral range cited by Lane implies that after a September hike, policy would formally cross the neutral threshold into restrictive territory. If economic data remains strong and inflation fails to moderate, the ECB could be forced to push rates to 2.75% or even higher, which would exert greater pressure on Eurozone sovereign bond markets, bank lending conditions, and corporate investment.
For investors, the signal that major global central banks are pivoting hawkish in unison is reshaping risk pricing across asset classes. Eurozone short-dated government bond yields already reflect expectations of a September hike, and if Schnabel's stance gains traction among more Executive Board members, market pricing for the terminal rate could shift further upward. Meanwhile, if the Bank of Japan hikes in September, the narrowing U.S.-Japan interest rate differential could lend support to the yen, in turn affecting global carry trade flows. On the U.S. side, while discussions about the discount rate do not directly equate to changes in the federal funds rate, they indicate that inflation pressures continue to command broad attention within the Federal Reserve system, and market expectations for the timing of rate cuts could be pushed further back.
The resilience of the Eurozone economy and the stickiness of inflation present a dilemma for ECB policymakers. On one hand, second-quarter growth of 0.4% suggests the economy can withstand further monetary tightening. On the other hand, persistent energy price pressures—particularly the winter supply risk posed by low natural gas storage levels—could keep inflation above target for an extended period. Schnabel's remarks indicate that the ECB's internal bias is to maintain or even intensify tightening until inflation is fully under control, rather than waiting for lagging indicators such as wage growth to confirm before acting.
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