ECB’s Visco: Should Not Underestimate Danger of Hiking Interest Rates Too Rapidly for Economic Prospects

31 October 2022

By David Barwick – FRANKFURT (Econostream) – The European Central Bank should not underestimate the danger of hiking interest rates too rapidly for economic prospects, if the latter turn out to be gloomier than anticipated, ECB Governing Council member Ignazio Visco said on Monday.

In a speech at World Savings Day 2022, Visco, who heads Banca d’Italia, said that inflation demanded ‘a decisive intervention by the Governing Council of the ECB aimed at averting the danger of it being translated into expectations’ and generating a wage-price spiral.

‘The rapid deterioration of the economic outlook, which is affected above all by the exceptional increase in energy costs, still requires to act progressively, carefully considering the risk of prolonging an unacceptably high inflation and also taking into account, with equal attention, the possible repercussions of the changes in the economic situation’, he said.

‘Aware of the risks to financial stability and of the implications for maintaining price stability in the event of a more serious, unexpected worsening of the economic situation, we can certainly discuss the pace at which to raise official rates, but I believe that there should be no doubts about the direction taken, nor about the fact that their level is not yet consistent with the achievement of the target of 2% inflation in the medium term’, he continued.

There were so far ‘no clear signs of a significant "disanchoring" of inflation expectations from the objective of price stability’, Visco said. The growth slowdown and the absence of widespread wage-indexation in the Eurozone ‘also seem to contain the risk’ of wage-price spiral, he said. Monetary policy normalisation is meant to head off the materialisation of such risks, he said.

The speed of normalisation and its terminal point could not be determined in advance, he said. ‘The high uncertainty requires proceeding gradually, carefully evaluating the adequacy of the monetary orientation on the basis of the evidence that will gradually become available’, he said.

‘However, the danger that the deterioration of the economic outlook will turn out to be worse than expected, making an excessively rapid step in the normalization of official rates disproportionate, should not be underestimated’, he said. ‘This is a risk that the Council will have to take into account in the coming months, just like letting inflation remain excessively high for too long.’

The decision last Thursday to increase official borrowing costs by another 75bp meant that ‘a substantial step forward was taken in the action of reabsorption of monetary accommodation, largely removing the rate on banks' deposits with the Eurosystem from the negative levels that had been necessary to hinder the risk of deflation and limit the fallout of the pandemic crisis’, he said

Visco noted market expectations suggesting that real one-year rates remained ‘very low and would barely become positive by the end of 2023.’

Referring to quantitative tightening, he said that the Governing Council had ‘postponed the discussion on the timing and modalities’ and for now would maintain the flexibility of pandemic emergency purchase progamme (PEPP) reinvestments.

The Governing Council would need to pay close heed to financial stability ramifications of its decisions, he said. However, he also urged ‘prudence’ on the part of the Italian government in order for a ‘decisive and persistent decrease’ of Italian sovereign yields.

‘Following the necessary normalization of monetary conditions, the cost of servicing the debt is set to rise’, he said. ‘This makes it all the more important to outline a realistic path to continue the phase of gradual recovery from the high levels of public debt to GDP that began in the last two years. It would be a decisive signal of credibility for the markets, which would translate into lower sovereign risk premiums, containing the interest burden and reducing the effort required to achieve budgetary targets.’

Global economic uncertainty had ‘significantly increased’ in the last months, he said. ‘The worsening growth prospects are widespread.’