ECB Should Be Prudent and Avoid Abrupt Moves, Panetta Says

22 March 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – European Central Bank Governing Council member Fabio Panetta said on Wednesday that abrupt policy moves should be avoided and that further tightening must be prudent.

Speaking at the ECB and Its Watchers conference, he said that the ECB should take into account the restrictive impact of financial instability and rate hikes from other central banks.

‘Our tightening must be calibrated prudently’, he said. ‘This prudent approach holds truer still as our policy rates move more firmly into restrictive territory, inflationary forces ease and the risks to the inflation outlook become balanced.’

He warned that ‘[a]t times like this, abrupt policy moves are not necessary.’

‘[W]hen calibrating our measures we should consider the restrictive impulse coming from the global tightening and from the vulnerabilities that are emerging in the financial sector abroad’, he said.

‘[M]onetary tightening in the United States is also resulting in tighter financing conditions in other jurisdictions, including the euro area’, he said. There was therefore a ‘risk of overtightening if central banks do not factor in the feedback loops they create.’

Tightening ‘may also be amplified by the recent financial tensions in global banking markets’, he said. He argued that tensions would induce banks ‘to transfer the rate hikes more rapidly – and to a greater extent – to their customers on both sides of the balance sheet’, as they became more sensitive to deposit outflows.

The ECB needed to ‘navigate between the risk of underreacting – which could prolong the inflationary effects of these shocks – and that of overreacting, which could turn volatility into instability’, he said.

‘[M]onetary policy must perform a difficult balancing act’, he said, it must ‘remain fully adaptable to changing developments, given the prevailing uncertainty, the lags with which it operates and the risk of sudden financial tensions.’

He reiterated that this required a ‘data-dependent approach that does not prejudge future policy decisions and that reflects the risks on both sides.’

‘We need to maintain our disinflationary stance until we see convincing signs that inflation is returning to our target’, he said.

Regarding inflation expectations, they remained ‘anchored at our target’, he said. ‘Robust wage growth over the next three years is also consistent with our projections’, which show inflation returning close to target in 2025, he said.

He warned however, that ‘the risk is that wage and price-setting dynamics could make high inflation stickier and eventually feed into inflation expectations is high; this risk needs to be closely monitored.’

Profits were contributing to inflation partially due to fiscal policy, he said: ‘There is a peculiarity in the last few years. We had a recession with very high profits, and the profits remain high because the public sector is an enabler.’

Profiteering strategies that increase inflation and the risk of second-round effects ‘would trigger a monetary policy reaction’, he said, however ‘other authorities should also intervene.’

‘These are externalities that are coming from those sectors that are taking advantage’ of supply-demand mismatches, he said. He argued for other authorities to take action to counter increased profits because monetary policy action would imply ‘sharing the costs of this action across different sectors’, rather than focus on those enjoying higher profits.