By Valentina Za
MILAN (Reuters) -The European Central Bank should return to a more forward-looking approach in setting monetary policy and provide more guidance on future moves now that post-pandemic shocks are abating and inflation normalising, a top policymaker said.
ECB Governing Council member and Bank of Italy Governor Fabio Panetta said on Tuesday the euro zone economy was returning into “charted territory” after the “exceptional shocks of 2022-2023” and inflation forecasting errors were normalising.
The ECB now needs to “focus on the sluggishness of the real economy” and move official interest rates into “neutral, or even expansionary, territory,” Panetta said in the text of a speech at Milan’s Bocconi university.
“With inflation close to target and domestic demand stagnant, restrictive monetary conditions are no longer necessary,” he said, adding inflation could fall well below target in the absence of a sustained recovery.
“A scenario that would be difficult for monetary policy to counteract and should therefore be avoided,” he said.
The ECB has cut interest rates three times since June after seeing inflation, which had hit double digits in the wake of Russia’s invasion of Ukraine in 2022, drop to its 2% target.
Its most recent cut, in October, saw it reduce the rate it pays on bank deposits by a quarter of a percentage point to 3.25%.
“We are probably still a long way from the neutral rate,” Panetta said.
Economists define the neutral rate as one that neither restricts nor spurs economic growth and see this in the euro area at between 2% and 2.5%, although estimates are as high as 3% and as low as 1.75%.
Investors expect the bank to lower borrowing costs by another quarter of a point at its next meeting on Dec. 12, followed by more cuts through the spring.
This would leave the ECB’s deposit rate at 1.75% to 2.0%.
Having managed to steer the euro zone’s economy through uncharted waters, the ECB should change its “meeting by meeting” approach to monetary policy dictated by the exceptional circumstances of the past two years, which forced it to give less weight to forecasts, Panetta said.
“We can now return to a more traditional, genuinely forward-looking approach to monetary policy, in line with our medium-term orientation.”
Panetta also urged the ECB “to provide more guidance on the expected evolution of our policy than has been the case in the recent past.
“This will help firms and households to form their views on the future path of policy rates, thereby supporting demand and the recovery of the real economy”.
Wrong-footed by a surge in inflation in 2021-22, the ECB has ditched its habit of providing official guidance about the future path for monetary policy.
Instead, it has insisted it would make decisions ‘meeting by meeting’ based on incoming data – albeit not without the occasional hint about what to expect.
Panetta said this meeting by meeting, data driven policy did not fit well with the more forward-looking approach that he called for.
(editing by Gavin Jones)