ECB’s Panetta: We Need To Take Into Account Risk of Overtightening
16 February 2023
By Xavier D’Arcy – FRANKFURT (Econostream) – European Central Bank Governing Council member Fabio Panetta said on Thursday that policymakers should be aware of the risk of overreacting and that smaller, non-mechanical rate hikes would allow monetary policy to avoid costly mistakes.
Panetta, who sits on the ECB’s Executive Board, said that forward guidance was not appropriate in the current period of uncertainty and the central bank should provide clarity on its reaction function but avoid unconditionally committing itself to monetary policy moves.
‘We no longer need to overweight upside risks to avoid worst-case scenarios’, he said. ‘We now need to take into account the risk of overtightening alongside the risk of doing too little.’
Following the recent tightening of monetary policy, ‘the extent and duration of restriction have become increasingly relevant’, he said. ‘By smoothing our policy rate hikes – that is, moving in small steps – we can ensure that we calibrate these two elements more precisely, remaining truly data-dependent and avoiding mistakes.’
Given that the euro area now faced ‘inflation uncertainty in both directions’ and policymakers were ‘not constrained in using interest rates’, forward guidance was not needed, he argued.
‘In fact, it would be tantamount to tying our own hands at a time when the inflation outlook can change rapidly’, he said.
With the risk to the inflation outlook more balanced, 'a data-dependent approach is a prerequisite to avoiding costly mistakes', he said.
According to Panetta, ‘so far there is no convincing evidence that inflation expectations are de-anchoring’.
Although higher wage increases did not necessarily imply a risk to the ECB’s ability to return inflation to target, they were nonetheless ‘still a source of upside risk’, he said. The ECB ‘cannot rule out that stronger and sustained wage dynamics will take hold if above-target inflation proves to be persistent’, he said, adding that ‘I consider this risk broadly unchanged compared with the December projections.’
The reduction of government spending on energy support and the increased targeting of such measures towards lower-income households were ‘contributing to the rebalancing of risks to inflation’, he said, whilst falling energy prices imply that energy support measures will be less extensive than foreseen in the ECB’s December projections.
Despite uncertainties about the pass-through of lower energy prices to core inflation, ‘the direction of core inflation will eventually follow that of headline inflation, just like what happened on the way up’, he said, although ‘core inflation cannot turn on a dime’.
On the outlook for monetary policy, he said that ‘we should keep our policy tight until we see inflation firmly converging back to 2% over our policy horizon, taking into account the lags with which our monetary policy operates.’