Actions to combat climate change are likely to keep energy prices high for longer and force the European Central Bank to withdraw its incentives sooner than planned, one of its senior officials warned.
Isabel Schnabel, the ECB’s executive in charge of market operations, said the proposed move away from fossil fuels to a greener, low-carbon economy “poses measurable upside risks to our medium-term base projection of inflation.”
After the economy recovered from the effects of the coronavirus pandemic, a sharp rise in energy prices drove inflation to 5 percent in December, a record high for the euro zone. However, the ECB has forecast a decline in energy prices and has pledged to maintain its ultra-loose monetary policy for at least another year.
However, the inflationary effects of the energy transition could force the central bank to reconsider this position, Schnabel said via video link at the annual meeting of the American Finance Association on Saturday.
“There are cases in which the central banks have to break the prevailing consensus that monetary policy should pay attention to rising energy prices in order to ensure price stability in the medium term,” said Schnabel.
Energy prices in the 19 countries that share the euro rose by 26 percent in December compared to the previous year, almost reaching a record high from the previous month. Natural gas prices reached record highs in the region last year, driving wholesale electricity prices to 196 euros per megawatt hour in November – almost four times the average level before the pandemic – said the ECB chief.
“While energy prices have often fallen as fast as they have risen in the past, the need to step up the fight against climate change may mean that fossil fuel prices not only have to stay high now, but must rise if we do it want to achieve the goals of the Paris climate agreement, ”said Schnabel.
The German economics professor, who joined the ECB’s executive board two years ago, has emerged as the loudest critic among the top managers of its extensive bond-buying program, which has acquired a portfolio of 4.7 trillion euros in assets since the beginning of seven years ago .
The ECB responded last month to concerns about rapidly rising prices by announcing a “gradual” reduction in its bond purchases from € 90 billion last year to € 20 billion in the month to October. But other central banks – including the Federal Reserve and the Bank of England – are tightening their monetary policies faster, and critics say the ECB should do the same.
Schnabel outlined “two scenarios in which monetary policy would have to change course”. One is if persistently high energy prices led consumers to expect continued high inflation rates, creating a 1970s-style wage-price spiral. However, she said that “so far” wages and union demands have been “comparatively moderate”.
The second scenario is that measures to combat climate change, such as a carbon tax and measures to compensate poorer households for higher energy costs, increase inflationary pressures – as recent studies suggest – she said.
ECB chief Philip Lane seems to disagree. He told Irish broadcaster RTE on Friday that while rising energy prices were “a big concern”, there was “less upside potential this year” and that he was confident that “supply will shift, pressure should ease overall this year “.
Like most central banks, the ECB was surprised by the continued inflation. Last month it raised its inflation forecast for the euro zone for this year to 3.2 percent, but forecast that it would fall below its 2 percent target again next year.
However, Schnabel said this assumption was “derived from futures curves” showing that energy prices would not add to headline inflation over the next two years, adding that “these estimates might be conservative”. If oil prices stayed at November 2021 levels, that would be enough for the ECB to meet its inflation target in 2024.