By Marta Vilar – ROME (Econostream) – European Central Bank Governing Council member Fabio Panetta said on Tuesday that negotiations between the United States and Iran could result in lower energy prices than assumed in the ECB’s June staff projections but warned that the economic outlook remained “fragile.”

Speaking at a conference in Rome, Panetta, who heads the Banca d’Italia, said the outlook deteriorated significantly with the outbreak of the Middle East war, which pushed up input costs, selling prices and short-term inflation expectations while weakening consumer confidence, reducing expectations for services activity and tightening financial conditions.

"The euro area faced a difficult combination: renewed inflationary pressures from commodity prices and supply chains, together with weaker confidence and demand prospects," he said. "This is precisely the environment in which monetary policy becomes more complex."

Panetta argued that the ECB should avoid both dismissing the latest energy shock as temporary and treating it as a repeat of the energy crisis experienced in 2022.

He said central banks should not simply "look through" the shock because disruptions to global energy supply and uncertainty surrounding the Strait of Hormuz could generate persistent price pressures and broader supply chain disruptions.

Monetary policy could not prevent higher energy prices from spreading through the economy but had to prevent them from becoming embedded in firms' and workers' expectations, he said.

“Once a shock turns into a broader inflationary spiral, the cost of restoring price stability becomes materially higher,” he said.

On the other hand, Panetta said that the current environment differed materially from that of 2022, with weaker demand, higher real interest rates, a greater impact on oil than gas prices and a euro area economy that had become less vulnerable to energy shocks thanks to greater LNG import capacity and increased renewable electricity generation.

"The ECB must navigate between these two extremes," Panetta said. "It must neither dismiss the shock as temporary nor respond as if the economy were in the same position as four years ago."

He said that several factors led to believe that first-round inflation effects of a large energy shock could pass through to inflation “relatively quickly,” but noted that these shocks also depressed demand, thus reducing households’ purchasing power firms’ margins and income prospects.

“Consumers may cut discretionary spending; firms may postpone investment,” he said. “The result is a downward shift in aggregate demand, which has a negative effect on inflation.”

He said that policymakers should focus not only on the immediate increase in prices but also on whether second-round effects emerged, whether inflation expectations remained anchored and how much weaker demand would offset inflationary pressures over the medium term.

Turning to the ECB's June policy decision, Panetta said the Governing Council had raised the deposit facility rate by 25bp because Eurosystem staff projections showed inflation rising to 3.0% in 2026 before returning to target only in the second half of 2027, while inflation risks remained tilted to the upside.

He said that the recalibration had also been aimed at preserving the anchoring of medium-term inflation expectations and that the decision had been judged “robust” across a range of scenarios.

“The ongoing negotiations between the United States and Iran may lead to lower energy prices than assumed in the June baseline projections,” he said. "But the outlook remains fragile.”

According to Panetta, upside risks to inflation and downside risks to growth remained, requiring "constant monitoring of geopolitical developments, energy markets, supply chains, wages and inflation expectations."

The ECB should avoid committing to a predetermined interest rate path, he said.

 

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