MNI POLICY: Inflation Key to PEPP Changes - ECB Schnabel In FT

By Luke Heighton

     FRANKFURT (MNI) - The European Central Bank's monetary policy will not

change in response to the German Constitutional Court's ruling against the

Public Sector Purchase Programme, Executive Board member Isabel Schnabel said in

an interview with the Financial Times published Wednesday

     The Governing Council is likely to use staff inflation forecasts due to be

unveiled at the June 4 meeting to help decide whether an increase in the size

and composition of the newer Pandemic Emergency Purchase Programme is required,

she added.

     Schnabel also ventured into the area of euro area government bond yield

spreads, saying the ECB was watching spreads closely and would move to act if a

widening of spreads lead to a market dysfunction.

     Here are the key points from the interview with the Financial Times.

     - The ECB is not adjusting its monetary policy "in any way" in response to

the May 5 court ruling, Schnabel said, noting the bank has shown repeatedly that

it takes into account the proportionality of its monetary policy actions,

including those relating to PSPP. Asked whether the ECB could find itself

conducting PSPP operations without the participation of the Bundesbank, Schnabel

replied: "That is not going to happen."

     - The ECB is "not targeting spreads, but we are watching them carefully."

"A very quick divergence in sovereign spreads poses risks of fragmentation that

may threaten the transmission of monetary policy to all parts of the euro area.

If we see such signs of fragmentation, we have to react. That doesn't mean that

in the end all spreads relative to the German Bund will be equal to zero - and

they shouldn't be, given different fundamentals. But a quick divergence of

spreads points towards market dysfunction with risks of running into

self-reinforcing spirals. The ECB certainly has to counter such developments."

     - The June 4 Governing Council meeting could result in a change to the size

or composition of PEPP, Schnabel indicated, the evolution of the medium-term

outlook a key element in the decision-making process. "If we see that the

situation has deteriorated," she said, "and if we judge that further stimulus is

needed, the ECB will be ready to expand any of its tools in order to achieve its

price stability objective. With respect to the PEPP, this concerns the size but

also the composition and the duration of the programme. We are ready to react to

new data coming in."

     - The euro zone will experience deflationary forces in the short-run,

Schnabel said, but the picture was less clear in the longer-run. "My main

concern, she added, "is disintegration, which would be very harmful. "We have to

avoid an increasing divergence within the euro area," she said.

     - "From a purely economic perspective," Schnabel said, "it is clear that

this asymmetry has to be countered by an appropriate policy response. Economic

divergence across the euro area would be "highly problematic" for the ECB, she

added. "This is not just about giving more loans, which risks exacerbating

divergence. We need transfers to those countries that are hit hardest."

     - "A safe European asset would certainly help integration and would also

foster the international role of the euro," Schnabel said. "These are the main

things we should focus on and we should not allow the European economy to

disintegrate in any way."

--MNI Frankfurt Bureau; +49-69-720-146; email: luke.heighton@marketnews.com

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$X$$$,MT$$$$,M$$EC$]