ECB’s Panetta: Must Be Prudent to Avoid Unnecessary Harm to Economy

3 August 2023

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Fabio Panetta on Thursday called for monetary policy to be set so as to avoid needlessly hurting the economy.

In a speech at Bocconi University in Milan, Panetta said, ‘[W]e must be prudent in calibrating our monetary policy stance if we are to reach our inflation target without harming economic activity unnecessarily.’

The speed of policy transmission could surprise on the upside, he cautioned, and quick policy tightening, including with respect to the ECB’s balance sheet, could have a greater impact on financial conditions and thus on economic and inflation developments.

‘Emphasising persistence may be particularly valuable in the current situation, where the policy rate is around the level necessary to deliver medium-term price stability, the risk of a de-anchoring of inflation expectations is low, inflation risks are balanced and economic activity is weak’, he said.

‘Under such conditions, relying solely on an aggressive approach to rate hikes might amplify the risk associated with overtightening, which could subsequently require rates to be cut hastily in a deteriorating economic environment’, he said.

Interest rates were ‘now firmly in restrictive territory’ and ‘around the level necessary to deliver medium-term price stability’, but it will be ‘some time’ before inflation is again consistent with the ECB’s objective, he said.

Keeping interest rates high was a viable alternative to hiking further, he said: ‘In other words, persistence matters as much as level.’

According to Panetta, fading supply shocks were leading to reduced pipeline price pressures, ‘and the risks to inflation are becoming balanced.’

‘Underlying inflation is moderating’, he said. ‘Inflation pressures at the early stages of the price formation process are easing, with producer price inflation (PPI) declining further in recent months’

Core inflation was in any case a lagging indicator of inflation, he argued.

Moreover, economic risks were to the downside, he said, with demand conditions ‘likely to remain weak as the impact of monetary policy strengthens, governments unwind the fiscal policy measures they adopted in response to the energy crisis and the consumption impulse from excess savings fades.’

This suggested a lower likelihood of high wage growth, he reasoned.