ECB’s Visco Urges – Again – That Rate Moves Consider Worsening Economy and Growing Stability Risks

16 November 2022

By David Barwick – FRANKFURT (Econostream) – The European Central Bank still needs to hike rates, but there are reasons to think that it can do so at a slower pace than to date, ECB Governing Council member Ignazio Visco said Wednesday.

In an appearance before Italian lawmakers, Visco, who heads Banca d’Italia, called for striking the proper balance ‘between the risk of inflation remaining high for too long and the risk that the worsening economic situation will eventually bring price growth in the medium term below target’, while keeping financial stability and particularly fragmentation risks in mind.

‘The reference rates of monetary policy - which had been reduced to extraordinarily low levels in the euro area in response to the economic repercussions of the severe economic and financial crises of the past decade - are still below the level consistent with the achievement of our inflation target in the medium term’, he said. ‘The need for continued restrictive action is therefore clear, even if the case for a less aggressive approach is gaining ground.’

In essence, Visco’s remarks reiterate those he made on October 31, when he urged that the ECB not underestimate the danger of hiking interest rates too rapidly for economic prospects, if the latter turn out to be gloomier than anticipated.

We reproduce Visco’s key October 31 comments to make clear that his statements today covered basically the same ground, conceding the need for further adjustment of the policy rates while arguing that economic deterioration and heightened financial stability risks constituted reasons to proceed more slowly:

‘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.'

‘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. 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.’

Visco called the 200bp of ECB tightening so far ‘a substantial step forward’, and took note of those who feel the ECB is acting too aggressively, saying that ‘[i]n such an uncertain context, I think it is useful to take these observations into account.’

‘I believe, however, that the path taken is the one necessary to keep inflation expectations anchored and to contain the risk of a price-wage spiral that would amplify the negative effects of inflation on our economies’, he continued.

There are some reasons to think inflation would be back at 2% by end-2024, he said, arguing that wage developments ‘have so far remained moderate on the whole’ and long-term inflation expectations are anchored.

Still, while ‘there are no clear signs either of a strong run-up in prices and wages or of a significant 'unwinding' of inflation expectations’, he said, ‘the risks remain significant and this explains why monetary policy action can only continue in the direction taken.’

Visco acknowledged the desire for more specifics about the monetary policy path ahead, but dismissed speculation as to the neutral rate, the terminal rate and the like as ‘levels whose estimation is uncertain, to say the least, and which, if they make sense at all, relate to conditions in the economy that are still far removed from the present.’

Therefore, policy decisions must be made on the basis of available data ‘with the utmost care, but without formulating a priori more or less realistic paths along which to proceed’, he said.

Making these decisions had become more difficult due to the sudden worsening of growth prospects after an initial post-pandemic surge, he said. ‘This, on the one hand, recalls the importance of bringing inflation back under control as soon as possible; on the other, it signals the risk that too rapid and pronounced rate hikes will end up amplifying the slowdown in productive activity, bringing price dynamics well below target’, he said.

‘There are also risks to financial stability, also related to the rapidly deteriorating macroeconomic environment’, he said. Were financial markets to fragment, this ‘could lead to an overall tightening of financial conditions far beyond what is necessary to contain high inflation’, he said, noting that the ECB would then deploy its Transmission Protection Instrument.