The following is an exclusive interview with European Central Bank (ECB) Executive Board member Isabel Schnabel.

**Question:** Could you assess the economic developments since the June economic projections were published? How is the eurozone currently performing compared to the baseline scenario?

**Answer:** The latest data confirms the resilience of the eurozone economy. Over the past year and a half, the eurozone has maintained quarterly growth rates of around 0.3%, essentially in line with potential growth. Given the various economic and trade policy uncertainties we have experienced, this performance is quite remarkable and confirms that eurozone economic resilience has exceeded expectations.

This also suggests that the recent strong GDP growth is not merely "demand front-loading" but reflects more fundamental improvements in the economy's underlying growth momentum. Indeed, this recovery has benefited from robust domestic demand growth - accommodative financing conditions have supported demand, thereby offsetting the recent decline in net exports.

Looking ahead, some factors that previously constrained economic growth will become supportive forces. In particular, the conclusion of trade agreements has significantly reduced trade policy uncertainty, with agreed tariff levels not differing much from our June baseline expectations. Additionally, we expect significant fiscal stimulus.

These developments are consistent with recent Purchasing Managers' Index (PMI) trends, which indicate further improvement in economic activity.

Finally, the global economic outlook is also more optimistic than at the time of the June projections, as both Chinese and US economies have shown greater resilience.

**Question:** How do you view the inflation outlook?

**Answer:** Inflation overall aligns with expectations, currently stabilizing around 2%.

The key point is that in an era of increasingly frequent supply-side shocks, we cannot expect inflation to remain consistently at 2%. Looking ahead, inflation will experience some volatility: inflation trends over the next year will be significantly influenced by two factors - base effects from recent energy price fluctuations and some one-off government measures.

Monetary policy has very limited scope to control such short-term inflation volatility, and we must focus on medium-term inflation - this is our core measurement standard. Current projections show medium-term inflation will remain around 2%. This assessment is also consistent with ECB-related surveys (such as the Survey of Monetary Analysts and Survey of Professional Forecasters): these surveys show that medium-term inflation expectations are increasingly clustering around 2%, with only minor deviations in the short term. Therefore, market confidence that the current monetary policy stance can ensure medium-term price stability is continuously strengthening.

**Question:** How do you assess the balance of inflation risks?

**Answer:** I still believe inflation risks are overall tilted to the upside, mainly for four reasons:

First is food prices. Food price inflation has risen to its highest level since March last year, with extreme weather events being a partial driver. Despite euro appreciation, imported food price inflation remains elevated. Food prices are particularly crucial because they have an important impact on household inflation expectations formation.

Second is the exchange rate. In the current environment of robust domestic demand, the pass-through effect of exchange rate changes to consumer prices may be lower than assumed in our standard elasticity models.

Third is tariffs. I still believe that tariffs will generally push up inflation. Retaliatory tariffs have been temporarily shelved, and we find that uncertainty's dampening effect on demand is smaller than expected, and uncertainty itself has also declined.

More importantly, standard models typically cannot capture supply-side effects. If tariffs lead to higher input prices globally and this increase is transmitted through global production networks, it will create inflationary pressures worldwide. Additionally, supply chain disruptions may occur - as we've seen in the rare earth sector, with the US eliminating the "de minimis exemption" policy for small packages also causing similar issues.

Overall, these factors will collectively bring moderate inflationary pressure, which is consistent with conclusions from a recent Bank for International Settlements (BIS) article.

Fourth is fiscal policy. We expect significant fiscal stimulus, the direction of which itself has inflationary effects. The specific impact depends on whether the overall economy or specific sectors hit capacity constraints.

**Question:** How concerned are you about the euro exchange rate level?

**Answer:** I do not comment on exchange rate levels.

But from a historical perspective, the exchange rate volatility we observe is not particularly large - even when compared to the US dollar (which is the most important currency due to its central role in trade invoicing).

Second, the pass-through effect of euro appreciation to prices may be lower than predicted by standard elasticity models. Due to downward price rigidity, pass-through effects during currency appreciation tend to be smaller. Additionally, the factors driving euro appreciation are also crucial: current euro appreciation largely stems from market reassessment of relative growth prospects, and in such cases, pass-through effects are typically also diminished.

Finally, when discussing competitiveness, the real exchange rate is the core indicator. From a real effective exchange rate perspective, the euro remains well below historical peaks, with limited overall volatility.

Therefore, my concern about current exchange rate trends is relatively low.

**Question:** Some argue that US tariff increases will prompt China to "dump" excess goods to other regions including the eurozone, thereby pulling down local prices. Do you observe such situations?

**Answer:** US tariff increases will lead to overall adjustments in global trade patterns. For example, US importers may reduce purchases of Chinese goods, which could actually benefit eurozone exporters.

But if China indeed has excess goods, Chinese exporters may be incentivized to recoup lost global market share through price reductions. However, looking at China's overall export prices, this is not the case - in fact, Chinese export prices have recovered somewhat, with prices of some typical consumer goods (such as electronics) currently rising again. This may be because intense domestic competition in China has reached bottlenecks (as evidenced by the Chinese government's recent "anti-involution" campaigns), thereby limiting room for price reductions. While prices of goods imported by the eurozone from China remain low, they show no new abnormal trends. Therefore, we have not yet observed signs of large-scale Chinese goods dumping into the eurozone.

Additionally, from a scale perspective, Chinese goods imports' impact on eurozone inflation is insufficient to be dominant. For example, Chinese imports account for only 1.4% of German consumer goods.

**Question:** You mentioned that market confidence in the current monetary policy stance's ability to achieve price stability is continuously strengthening. Could you explain this in detail? Does this mean that based on currently available information, you believe no further rate cuts are needed?

**Answer:** At the current juncture, I see no reason to adjust the monetary policy stance in any direction. Current interest rate levels are in a reasonable range: medium-term inflation is expected to remain around 2%, inflation expectations are stable; employment is at full levels, and economic growth aligns with trends.

Looking beyond September, we must recognize that in a shock-prone world, we cannot "fine-tune" to keep inflation consistently at 2% - President Lagarde emphasized this point in her speech earlier this year. This means the ECB should only act when inflation shows substantial, persistent deviation from target that could undermine inflation expectations and thereby threaten medium-term price stability. We can tolerate moderate deviations of inflation above and below the target level.

Therefore, absent major shocks, I see no need to adjust the monetary policy stance.

But you mentioned that projections still include one further rate cut, and markets have largely priced this in. Do you think the 2% medium-term inflation target can be maintained even without further rate cuts?

Models cannot statistically distinguish the difference between "one more rate cut" or "one fewer rate cut" - this is not an engineering problem. Therefore, we must comprehensively assess the overall economic and inflation environment, as well as medium-term inflation projections, and make judgments about interest rate levels. I believe current policy already has slightly accommodative attributes, so under current circumstances, there is no reason for further rate cuts.

**Question:** What circumstances would change your view? Perhaps we could ask further, for example, in the weeks following the trade agreement, do you think you sufficiently understand tariff impacts?

**Answer:** We continuously monitor new developments, and every new piece of data provides us with more information. If new situations emerge that could fundamentally change my assessment of medium-term price stability, that might become a reason to adjust the monetary policy stance. But currently, I have not observed such situations. On the contrary, despite tariff pressures, eurozone economic resilience still exceeds expectations.

**Question:** At what point would inflation below target start to concern you? Is there some "trigger factor" that would change your thinking?

**Answer:** This largely depends on whether there are signs that inflation expectations are "de-anchoring" to the downside. Given the upside inflation risks I mentioned earlier, and the relatively high inflation levels in "salient goods" like food, I believe the possibility of inflation expectations de-anchoring downward is extremely low - especially after years of high inflation. Additionally, looking at corporate selling prices, neither manufacturing nor services show signs of deflationary pressure.

**Question:** Negotiated wages grew 4% in the second quarter. How do you interpret this acceleration trend?

**Answer:** Wage data often exhibits volatility, and we should focus on overall trends - which currently still show wage growth decelerating. The significant growth in negotiated wages we observe is actually influenced by Germany's one-off payments in the first quarter of last year (which depressed wage data for that quarter). Excluding one-off factors, the data would more accurately reflect the situation: negotiated wage growth has stabilized at high levels, declining slightly from 4.4% to 4.3% in the second quarter. In contrast, compensation per employee growth began declining in 2023 and has now fallen to 3.8%. Our forward-looking wage tracking indicators and related surveys show wage growth will continue to decelerate, which is already incorporated into our projections. Nevertheless, wages remain one of the main cost drivers for businesses, especially service sector companies.

**Question:** Do you suspect tariff impacts have not fully materialized?

**Answer:** Certainly, tariff impacts have not been fully released. Their most direct impact will be felt in the US, and even in the US, we see certain economic resilience. However, we have begun to observe tariffs' upward pressure on US inflation - especially in goods sensitive to tariffs such as consumer electronics and furniture. I expect this inflationary pressure to intensify further in coming quarters, as companies exhaust inventories and increasingly feel cost pressures while becoming less willing to absorb additional costs by compressing profits. This requires our close attention - one lesson from the pandemic is that we find it difficult to completely isolate ourselves from global inflation dynamics.

**Question:** But the Federal Reserve has signaled possible rate cuts (rather than increases) this month, seemingly not sharing your inflation concerns. How does this affect your policy considerations?

**Answer:** The Federal Reserve System's core objective is to ensure that tariffs and related price increases do not evolve into more persistent inflation dynamics.

Regarding impacts on ECB monetary policy, recent practice has shown that even though Fed policy affects our decisions through assumptions in our projections and analysis, we can still implement monetary policy independently. In any case, US rate cuts would mean that after a period of interest rate divergence, US and European rates will converge again - previously the ECB's rate cut magnitude was already double that of the Fed.

**Question:** Markets are beginning to digest expectations of "Federal Reserve facing political pressure," as seen in gold prices, US long-term bond yields, and Bitcoin prices. Markets believe that for political reasons, the Fed may structurally tend toward accommodation. If the environment facing global central banks changes structurally (for example, the world's most important central bank faces political pressure or even political interference), how would this affect your thinking?

**Answer:** History has clearly demonstrated the benefits of central bank independence: it can reduce risk premiums and improve financing conditions for households, businesses, and governments. Therefore, any attempt to weaken central bank independence will lead to higher medium- and long-term interest rates.

The ECB is one of the world's most independent central banks, protected by EU Treaties. Recent capital flow data shows this independence benefits the eurozone: after the April tariff shock, global investors (in both bond and equity markets) injected substantial capital into the eurozone; simultaneously, non-eurozone companies issuing euro-denominated bonds has also expanded continuously. This reflects both high market confidence in the euro and trust in ECB independence.

To maintain this trust, we must adhere to our mission and ensure medium-term price stability - this is the best safeguard against any threats to independence.

**Question:** Do you think that as more central banks are forced to (or attempt to) follow Fed rate cuts, the world will fall into a vicious cycle of "competitive devaluation"?

**Answer:** Not at all. On the contrary, in a "fragmented world" with declining global supply elasticity, increased fiscal spending, and aging populations, inflation levels are more likely to rise. Therefore, I believe the timing for global central banks to resume rate increases may be earlier than most currently expect.

**Question:** If Fed independence is compromised, leading to some degree of excess inflation in the US, some inflationary pressure might transmit to the eurozone, thereby creating pressure on the ECB. Would a loss of Fed independence directly impact the ECB?

**Answer:** If Fed independence is truly compromised (which I sincerely hope will not happen), it will cause serious shocks to the global financial system and affect the ECB.

Specific impacts will depend on how events unfold. One key question is whether the dollar can maintain its current status. Overall, I tend to believe the dollar will retain its position, but if not, the global financial system will face uncertainty - as there is currently no clear alternative currency. I do believe the euro might benefit, but the global financial system currently cannot easily escape dependence on the dollar as the core currency.

**Question:** Multiple European central banks store gold reserves in New York (mainly at the Fed). Given current discussions about "imposing tariffs on gold" and concerns about Fed independence, do you think it's appropriate for central banks within the Eurosystem to continue storing gold reserves in New York? Or should discussions about reserve repatriation at least begin?

**Answer:** I do not comment on our gold reserves. But certainly, if there are any concerns about reserve security, we would definitely take responsive measures.

**Question:** You mentioned that declining dollar status might benefit the euro, but France is currently again experiencing political and budget crises similar to last year. This reminds international investors that the euro structurally still has weaknesses - because the eurozone has 20 different budget and sovereign debt systems, while the ECB can only serve as a safety net through the "Transmission Protection Instrument" (TPI). If the ECB wishes to maintain independence, to what extent should it intervene in political affairs (such as France's current political situation)?

**Answer:** I think your interpretation of the current situation may be too deep. France's current situation is not entirely new: France faces a severe fiscal situation and needs to pursue fiscal consolidation while promoting potential growth in a tense political atmosphere. Therefore, the current situation is mainly France's own issue, and I don't think it will have broader impacts on the euro.

**Question:** Would not activating the Transmission Protection Instrument (TPI) demonstrate ECB independence?

**Answer:** There are clear rules regarding TPI activation - it was established to address "unwarranted disorderly market volatility" in sovereign bond markets. We currently do not observe such conditions, and recent price reassessments merely reflect normal financial market functioning. Therefore, I think it's premature to discuss the possibility of activating TPI now.

**Question:** Turning to the new operational framework, how are banks responding to reduced liquidity? When do you expect discussions to begin on the framework assessment planned for next year?

**Answer:** The operational framework we determined in March 2024 is operating as expected and has been well received by financial markets and banks. Many central banks globally seem to be adjusting in similar directions.

Under the new framework, balance sheet normalization is progressing smoothly: banks' market funding has increased, and liquidity redistribution within the system is advancing.

Currently, banks' use of standard refinancing operations remains limited because excess liquidity remains ample, and banks' market funding costs are lower than using central bank refinancing operations.

Eventually, this situation will change, and bank demand for refinancing operations will increase. Banks should view standard refinancing operations as an integral part of daily liquidity management and an important component of diversified funding portfolios.

However, due to some autonomous factors, excess liquidity is declining slightly slower than expected. For example, banknote demand growth has slowed, and government deposits have declined more than expected.

This means we have more time to consider two issues: first, whether any parameters of the operational framework need adjustment, and second, how to design structural operations. Structural operations will have important impacts on banks' structural liquidity needs, but will only be launched after our balance sheet begins sustained expansion - with the prerequisite that banks can regularly use weekly refinancing operations (because such operations can provide marginal central bank liquidity on demand). Only when this prerequisite is met will we first launch structural refinancing operations, followed by structural bond portfolios at a later stage.

**Question:** Roughly when do you expect this to occur?

**Answer:** It's difficult to give an exact timeframe because excess liquidity development has considerable uncertainty. The advantage of our operational framework is that we don't need to predict exact timing because the system will adjust endogenously. But we must be prepared, and the banking sector also needs clear expectations. Therefore, we should initiate discussions about structural operation design well before they are actually launched.

**Question:** Will next year's (2026) assessment plan still proceed as scheduled?

**Answer:** We haven't determined the exact timing, but related work will definitely begin next year.

**Question:** Two years ago, you said Europe was lagging in innovation and technology application. Since then, the AI revolution has mainly occurred in the US and China, with Europe not even included in this landscape. What role does Europe hope to play in this transformation?

**Answer:** If Europe wants to play a role in this transformation, it must unite and seriously advance European integration. The European Savings and Investment Union (especially the Capital Markets Union) is crucial in this process. It's not that Europe lacks innovation - in fact, European innovation achievements are very rich, but these innovations have strong "national characteristics." Startups find it difficult to scale across Europe because there are 27 different regulatory systems, and this situation must change. This is why I strongly support the "28th regime" - similar recommendations appear in reports by Mario Draghi and Enrico Letta. The core idea of this system is: specialized regulatory frameworks can be established for specific areas (possibly limited to innovative companies), allowing companies to operate Europe-wide under unified rules. This will significantly reduce companies' expansion difficulties, and for Europe, if it wants to become an important participant in innovation, this is crucial.