ECB’s Panetta: Nominal GDP-Weighted Yield Increase Unwelcome, Must Be Resisted

2 March 2021

By David Barwick – FRANKFURT (EconoStream) –European Central Bank Executive Board member Fabio Panetta on Tuesday issued a ringing call for the ECB to ensure that nominal yields remain low, warning that financing conditions could otherwise tighten and push yet further into the future the return to price stability.

In a speech at an online event organised by Italy’s Bocconi University, a transcript of which was made available by the ECB, Panetta said that the ECB should ‘not hesitate’ to add to the pandemic emergency purchase programme (PEPP) envelope and exhaust its volume.

‘By keeping nominal yields low for longer, we can provide a strong anchor to preserve accommodative financing conditions’, he said. ‘Improvements in the outlook will then work in our favour through lower real rates, further supporting confidence in a sustained return of inflation to our aim.’

According to Panetta, the ECB’s present focus on maintaining favourable financing conditions ‘essentially means more focus on anchoring key financial variables – above all, lending rates and the yield curve – as key indicators of the monetary policy stance.’

That implies ‘progressively add[ing] accommodation’ to anchor nominal yields as inflation rises and thus allow real yields to decline. Lower real yields would be ‘welcome additional stimulus’ given the output gap and weak inflation, he said.

Such a policy would mean monetary policy had to ‘broadly identify what level of nominal yields it is aiming to achieve; to tailor its purchases to achieve that level; and to be ready to intervene to the extent necessary’, he said.

Given financing conditions were deemed favourable in December, that situation ‘should be seen as the reference point for our policy moving forward’, he said, implying that ‘the steepening in the nominal GDP-weighted yield curve we have been seeing is unwelcome and must be resisted.’

With euro area yields presently ‘well above the levels seen at the start of this year’, he said, ‘we should not hesitate to increase the volume of purchases and to spend the entire PEPP envelope or more if needed.’

Otherwise, he cautioned, financing conditions could tighten and further defer the achievement of price stability.

‘Eventually, firm commitment to steering the euro area yield curve may allow us to slow the pace of our purchases’, he said. ‘But in order to reach that point, we must establish the credibility of our strategy by demonstrating that unwarranted tightening will not be tolerated.’

Panetta conceded that ‘policy choices have become less clear-cut’ in 2021, given that ‘the end of the pandemic emergency is in sight and an incipient recovery is on the horizon’, though he allowed nothing more than ‘a good chance that a recovery will take hold in the latter part of this year.’

It would nevertheless be wrong ‘to conclude that there is less need for monetary policy support’, he said. 2021 ‘is still a “pandemic year”. And even if the pandemic ends soon, its economic consequences will not.’

It may not be that the best-case scenario materialises, he said. Policymakers are there to safeguard against the worst case, he said. The current ‘asymmetric balance of risks … requires an asymmetric reaction function’. Doing too little is far riskier than doing too much, he said.

If the output gap and the gap between actual inflation and price stability were not closed with ‘sufficient force’ because of policymakers being ‘too hesitant in providing the necessary degree of policy support or withdrawing it too quickly’, this could haunt the euro area for years, he warned.

The risk of overshooting the ECB’s price stability threshold is ‘negligible’, he reasoned, citing December staff macroeconomic projections calling in 2023 for HICP of ‘just’ 1.4% and core HICP of ‘just’ 1.2%.

The expected increase in inflation this year will be due to ‘one-off statistical’ and ‘will therefore be temporary’, he said. ‘Just as we looked though temporary negative inflation in recent months, we will look through this transitory hump in inflation’, he said.

Similarly, the economic recovery will only be gradual, with a return of output to pre-pandemic levels ‘in the course of 2022’, all while remaining ‘vulnerable to a series of downside risks’, he said. He noted the likelihood that slow vaccination progress and new coronavirus mutations would hurt sentiment and complained of  ‘undesirable contagion from rising US yields into the euro area yield curve.’

‘If unaddressed, this would lead to a tightening of financing conditions that is inconsistent with our domestic outlook and inimical to our recovery’, he said.

Panetta also cast doubt on the strength of the recovery, citing research showing that suppressed demand is generally weaker for services and arguing that saving rates would remain high ‘at least throughout 2021.’

Amid ‘substantial’ risks to private consumption, investment also cannot be counted on, being ‘likely to only increase gradually and cautiously’ while also susceptible to ‘a catch-up in corporate insolvencies’, he said.

‘A risk management approach would therefore clearly call for policy to eliminate these risks and reinforce the central growth path’, he said. ‘And, if we were to do “too much” and push the economy onto a stronger growth path, that would in fact be a welcome result.’