ECB’s Panetta: Need to Normalise Policy to Neutral or ‘Even Expansionary Territory’

19 November 2024

By Marta Vilar – MADRID (Econostream) – European Central Bank Governing Council member Fabio Panetta said on Tuesday that the ECB should ease its monetary policy to neutral or accommodative territory ‘if necessary’.

In a speech at Bocconi University in Milan, Italy, Panetta, who heads the Banca d’Italia, said that ‘with inflation close to target and domestic demand stagnant, restrictive monetary conditions are no longer necessary.’

The ECB should pay more attention to the weakening of the real economy, as the absence of a recovery could increase the likelihood of undershooting on inflation, he said.

For Panetta, inflation at 2% and a weak economy suggested that ‘the tightening bias in our official description of the monetary stance is no longer necessary’.

He also questioned the meeting-by-meeting, data-dependent approach as not preferable to the forward-looking strategy the ECB should now apply.

The ECB should give clearer indications of its future moves, he said.

Panetta expressed understanding for those who were ‘extremely cautious’ about such a change, but pointed out that forgoing guidance 'also carries its own risks, as it can make interest rates highly sensitive to economic news’, he said in reference to sharp moves in market expectations ahead of the October cut.

‘A ‘directional guidance’ would help to stimulate consumption and investment, thereby reducing the likelihood of a weak-demand scenario’, he indicated.

In the current situation, inflation forecasts were more relevant than data on price dynamics like estimates of underlying inflation, he said.

It would be ‘a mistake’ for the ECB to maintain a restrictive approach, as weak demand risked undershooting the inflation target, according to Panetta.

‘Instead, the ECB should face this situation with a neutral stance’, he said. ‘This way it could pause rate cuts if the undershooting is likely to be temporary – or cut rates further if the undershooting appears likely to persist.’

If the situation were to deteriorate, the ECB might need to cut rates below neutral, he observed, which was a ‘standard policy prescription’ that the ECB and the Fed had applied on past occasions.

The recovery of the manufacturing sector did not appear to be near, while the services sector could be slowing down, he said.

‘The extent to which exports will continue to support GDP in 2025 is unclear at best’ due to Donald Trump’s potential tariff hikes, he indicated. ‘Without a boost from exports, the euro area will need a strong rebound in domestic demand to grow.’

Inflation was expected to be bumpy in upcoming months because of base effects, but the baseline scenario was still for it to keep falling early next year and stay on target after that, he said.