FRANKFURT — As it heads toward its silver anniversary in May, the European Central Bank (ECB) has its eyes on a less conventional gift than most would want to mark the occasion — a more meaningful step toward a full fiscal union.
“We need to start thinking about permanent common fiscal tools,” ECB board member Isabel Schnabel said in an interview with POLITICO. “My birthday wishes are that political leaders manage to make further progress on European integration, including on the fiscal side.”
It’s a significant acknowledgement given the ability to borrow and raise taxes in its own name has been a long-standing ambition of the European Union and its institutions. Joint and permanent fiscal tools would make the ECB’s task of setting a single monetary policy for 20 diverse member states easier. The lack of them is one reason why national inflation rates diverge so wildly, ranging in March from 2.9 percent in Luxembourg to nearly 20 percent in Latvia.
Schnabel said Europe could build on its positive experience with the €800 billion program it launched in response to the pandemic — the so-called Next Generation EU program (NGEU). Its strength, she said, is that “it’s focused on fostering potential growth and hence also convergence in the euro area, which would be great progress.”
Her view — which is popular in some eurozone capitals — puts her at odds with many politicians in Germany and elsewhere in northern Europe, who continue to stress that NGEU should be considered a one-off measure, and warn that joint spending could ruin fiscal discipline. But Schnabel said such concerns should naturally be accounted for in the design of any fiscal capacity.
The EU is only gradually ramping up operations under the NGEU, partly because of the procedural checks put in place to ensure that governments use the money as intended. By the end of last year, the EU had borrowed €188 billion through the program, less than a quarter of its intended size, and disbursed just over €162 billion.
Even so, its mere existence has ensured that the eurozone’s recovery from the pandemic has been much more geographically balanced than after the global financial crisis 15 years ago, when weaker member states quickly ran into the constraints of the EU’s Stability and Growth Pact (SGP). The pact represents a set of fiscal spending rules that dates back to the common currency’s creation in the 1990s and aims to stop individual countries from taking advantage of the euro’s low borrowing costs to live beyond their means.
Schnabel said a lot is riding on the outcome of talks now in progress on reforming that pact. Those talks aren’t tied to any debate around a permanent fiscal framework, though.
“The ECB has a keen interest in a credible fiscal framework that ensures debt sustainability in a way that is growth friendly, not procyclical, and enforceable,” she said. “That is very important to us.” While Schnabel did not want to comment on active negotiations, she said that “maybe the biggest weakness of the [current] proposal is on the enforceability side and that needs to be discussed.”
The Commission’s proposals, published in November 2022, have been praised for dropping the existing focus on short-term budget developments but have been criticized for their continued reliance on financial sanctions to enforce discipline, which have never been applied and are widely seen as having lost any deterrent power they had.
Inflation battle not won
Long-term goals aside, the ECB still faces an urgent near-term problem in bringing down inflation. Headline inflation has come down sharply from a peak of 10.6 percent in October to 6.9 percent in March, but Schnabel stressed that the battle has not yet been won.
“Headline inflation is coming down relatively quickly, due to the sharp decline in energy price inflation,” she said. “But core inflation continues to surprise on the upside. It shows very strong momentum, and it stands at a historical high. Given the persistence of underlying inflation, plus the very strong momentum in food inflation, it’s far too early to declare victory.”
She said the ECB needs to see a “sustained decline in core inflation,” which strips out the volatile components of food and energy, and which rose to a euro-era high of 5.7 percent in March.
That development is one reason why Schnabel refuses to rule out another aggressive hike in the ECB’s rates at its meeting on May 4.
“Data dependence means that 50 basis points are not off the table,” she said. “The data we have so far shows that inflation is higher and the economy more resilient than projected.”
But she acknowledged that previous interest rate hikes are starting to have an impact, having contributed to a slowdown in credit growth even before the recent rash of bank collapses in the U.S. and Switzerland.
“The recent financial turbulence has led to higher uncertainty and is likely to lead to a further tightening in financing conditions,” she said. “This certainly needs to be taken into account.”
Looking further ahead, Schnabel suggested May is unlikely to be the end of the tightening cycle.
“I’m comfortable with the view that further rate hikes are needed,” she said. But she stopped short of endorsing current market expectations that the ECB’s key deposit rate could rise to around 3.85 percent from the current 3.0 percent.
