ECB’s Panetta: Euro Strength Causing Undesirable Financial Tightening

22 September 2020

By David Barwick – FRANKFURT (EconoStream) – The strength of the euro has led to tighter financial conditions and effectively attenuated the measures taken by the European Central Bank during the crisis, ECB Executive Board member Fabio Panetta said Tuesday.

In a speech at a meeting of the ECB Money Market Contact Group, a text of which was made available by the ECB, Panetta suggested that the problems that would derive from an unwarranted tightening of financial conditions implied the need for ongoing ‘substantial’ accommodation and for this accommodation to be adjusted with any increase in risks to the outlook.

‘The appreciation of the euro is one factor that we need to watch closely with regard to its implications for the medium-term inflation outlook, particularly at a time when current and expected inflation rates are both very low’, he said. ‘The sustained appreciation in the external value of the euro has brought about an undesirable tightening of financial conditions and has offset some of the monetary accommodation provided by our measures.’

Panetta included the euro’s appreciation prominently among causes for concern that also included the slowdown of the services sector; the prospect that ‘job and wage uncertainty is likely to remain elevated and give rise to continued precautionary behaviour among households’; the risk of perceived credit risk weighing further on investment; and the possibility of downward pressure on wage growth ‘further entrenching weak inflation dynamics’.

The adequacy of monetary policy must constantly be evaluated ‘in these difficult circumstances’, he said. ‘If we encounter shocks that compress demand and pose additional threats to price stability, our reaction function is clearly spelled out: a policy response is necessary and forthcoming.’

Panetta professed to be more concerned about risks to growth tilting downwards under the current circumstances than he would be ‘in less extreme times’, owing to ‘the sheer size’ of these risks. He dismissed the possibility of reaching 2% inflation or more in the medium term as ‘just a remote possibility’.

‘Faced with such a sizeable downward skew, there is a strong case for our reaction function to be asymmetric, as the risks of a policy overreaction are much smaller than the risks of policy being too slow or too shy to react and the worst-case scenarios materialising’, he said.

Monetary accommodation, along with complementary fiscal support, ‘may be needed for a long time’, he said, citing by way of example evidence from the ECB’s bank lending survey that credit standards would be much tighter in the absence of public guarantees for bank lending. Withdrawing these guarantees could spark a wave of corporate defaults, he said.

‘Similar problems would result, mutatis mutandis, from a premature tightening of financial conditions’, he continued. ‘For as long as the growth and inflation outlook are at risk, monetary policy support will have to remain substantial, and if those risks to the outlook rise, our policy impulse will have to rise in tandem.’