ECB: Panetta, prevarication on rate cut carries risk of new stagnation

For the ECB "acting in a timely manner is of paramount importance" in order to prevent a new phase of prolonged stagnation of the European economy from materialising. Acting means a cut in rates for Fabio Panetta, Governor of the Bank of Italy and member of the ECB board. Panetta, in a speech at a conference organised by the ECB in Frankfurt for the launch of the ChaMP network, returns to reiterate his position in favour of a rate cut, soon, by the Governing Council of the European central bank, which will have to be decided without delay.

From his first speech at Forex in Genoa in February to today, Panetta has never shown any hesitation about the direction the ECB's monetary policy should take. In that speech he vouched for the downward path taken by inflation, and today, in the text of his dinner speech in Frankfurt, he states that "the upside risks to inflation that dominated 2022-2023 have eased, leaving uncertainty about price dynamics more or less in balance, while the risks to economic activity remain tilted to the downside" and "need to be mitigated". The restrictive monetary policy is amplifying its effect on inflation this year more than it did in 2023, Panetta told the audience of economists, citing assessments made by the Bank of Italy staff. Then there is the 'slimming' effect of the balance sheets of the ECB and other eurozone central banks, which is another 'potential brake on economic activity'.

The emergence of downside risks to the economy's outlook "implies," he says in another passage, "that the ECB should consider the possibility that monetary policy may become too restrictive going forward. Monetary policy is obviously too restrictive if it ends up causing a deep recession,' the Governor notes, 'but it is also too restrictive if it pushes inflation below target and causes prolonged stagnation. We are reasonably far from the former scenario,' Panetta notes, 'but we cannot yet rule out the latter.

Then there is another argument,' says Panetta in the text of the speech in Frankfurt, 'in favour of a rate cut with the right timing (the market is betting on June, ndr) that of the productivity of companies. "Hesitations in the adjustment of interest rates to declining inflation," says Panetta, would discourage firms from investing, delaying the expansion of the capital stock, hampering productivity and generating a competitive disadvantage for the euro area in global markets.

The Governor then spent part of his speech reassuring that the risks to inflation from wage trends are fading. "Inflation expectations are well anchored and the probability of a self-sustained inflationary spiral is low. The labour market data," he adds, "suggest that wage growth may have peaked in 2023 and is evolving in line with our projections, which call for a return to our target in 2025. More importantly, discussing wages in isolation can be very misleading notes Panetta, they should be considered together with other variables such as profits and productivity. Firms, he says, "could absorb the increase in wages (and potentially also in total costs) by reducing profit margins. This compensation requires a temporary squeeze in profit margins and this is more likely to occur whendemand is weak and margins are high. This is currently the case in the euro area'.