ECB’s Panetta: ECB to React to Any Significant Financial Tightening

1 July 2020

By David Barwick – FRANKFURT (EconoStream) – Any significant tightening of financial conditions will elicit a policy reaction from the European Central Bank until the fallout from the pandemic has been overcome, ECB Executive Board member Fabio Panetta said Wednesday.

In a speech at a Capital Markets webinar organised by the European Investment Bank and the European Stability Mechanism, Panetta, according to a text made available by the ECB, cautioned against reading anything into recently improved economic data.

‘Our reaction function should … be clear: the ECB will respond to any significant tightening in financing conditions for as long as the negative effects of the COVID-shock persist’, he said. ‘We remain ready to adjust all our policies depending on how incoming data affect our assessment of the medium-term inflation outlook.’

Panetta argued that monetary policy has to avoid the possibility of a ‘significant non-linearity’ in the economy’s reaction to financial tightening. ‘The case for acting pre-emptively and forcefully becomes even clearer when one considers the potential “hysteresis” effects which the COVID-19 shock could trigger’, he said. Furthermore, macroeconomic policies complement each other, constituting ‘another important reason for forceful monetary policy measures’, he said.

Although soft data show the economy hesitantly returning to growth, these signs ‘need to be taken with a pinch of salt’, given high uncertainty, he said. The baseline scenario embodied in ECB staff macroeconomic projections depends on a ‘strong growth bounce back’ in 3Q, he observed.

Uncertainty surrounds the question of whether the economy is truly set to return quickly to a pre-pandemic level of output and ‘a healthy growth and inflation path’, he said. There are three main threats to such an outcome, he said.

The first is that global economies are unlikely to recover in concert, he said, and this could hamper growth and inflation. Moreover, a weak recovery could trigger ‘endogenous recessionary forces’ that impact the financial sector, he said, highlighting in this context the possibility that employment may get worse before it gets better. High uncertainty is a third risk, he said, and reflecting in part worries about how the economy will look post-crisis.

The ‘key question’ facing the ECB is how these factors will play out with respect to medium-term inflation, he said. If the risks to demand materialize, they will be ‘unambiguously disinflationary’ he said. The possibility that the pandemic will harm supply at the same time the policy response shores up demand, on balance producing inflation, ‘does not correspond with the situation we face’, he said.