Italy central bank chief says time for interest rate cuts is ‘fast approaching’

GENOA: The moment is "fast approaching" for the European Central Bank (ECB) to cut interest rates, and timely and gradual steps could help to reduce ensuing volatility on financial markets and in the economy, a top policymaker said on Saturday.

Addressing the Assiom Forex meeting in Genoa, ECB Governing Council member Fabio Panetta said the next monetary policy move had to reflect a situation in which disinflation is ongoing and a wage-price spiral unlikely, while rate hikes are proving to have a stronger effect on the economy than in the past.

"The time for a reversal of the monetary policy stance is fast approaching," said Panetta, who became Bank of Italy governor in November after a stint as an ECB executive board member.

"We need to consider the pros and cons of cutting interest rates quickly and gradually, as opposed to later and more aggressively, which could increase volatility in financial markets and economic activity," he added.

Fabio Panetta, who became head of the Banca d’Italia in November, said inflation in the euro area was falling faster than expected, challenges were intensifying for Europe’s already stagnant economy and recent data “clearly point to ongoing disinflation”.

“Fears that inflation would stop falling after the initial rapid decline — the ‘last mile problem’ — now appear unwarranted: inflation is falling at the same rate or faster than it has risen,” Panetta said.

He added that after the eurozone economy stagnated for five quarters, with the region’s industrial sector “in recession” and bank lending slowing, “disinflation is at an advanced stage and progress towards the 2 percent target [for inflation] continues to be rapid”.

Eurozone inflation has declined rapidly from its record high of 10.6 per cent in October 2022, after a surge in energy and food prices faded. In January, annual price growth in the bloc was 2.8 per cent, close to the ECB’s target of 2 percent.

The European Central Bank held interest rates at a record-high 4 percent last month and reaffirmed its commitment to fighting inflation even as the time to start easing borrowing costs approaches.

The debate is now focussed on whether the ECB will start to cut rates as early as April or opt to delay.

"Any speculation on the exact timing of monetary easing would be a sterile exercise and disrespectful to the ECB Governing Council as a collegiate body," Panetta said.

The ECB ended its fastest-ever cycle of rate hikes in September.

INFLATION DEBATE

In recent weeks, key policymakers have argued that more evidence that inflation is heading back to target is needed before any rate cuts, despite growing confidence that price pressures are easing.

"What should be discussed now are the conditions to start monetary easing, while avoiding risks to price stability and unnecessary damage to the real economy," Panetta said.

Addressing concerns raised by more hawkish policymakers, Panetta said downside risks to inflation expectations had emerged and fears about the 'last mile problem' of getting prices down appeared unwarranted, with inflation falling just as fast as it had risen.

Also, strong nominal wage growth, which could pose risks, is being offset by the decline in other costs so that firms' total production costs, the main inflation driver, have stopped increasing.

With costs stable and demand weak, businesses are less likely to pass on wage increases to consumers.

Panetta played down inflation risks stemming from the Red Sea crisis saying maritime transport accounts only for a small portion of total production costs.

"Here too, low demand and high inventories reduce the likelihood of higher transport costs being passed on to prices to a significant extent," Panetta said, adding an escalation of tensions could not be ruled out.

Investors are betting the ECB will start cutting borrowing costs as early as April. But the likelihood of that receded last week after other rate-setters warned there were still risks of fresh pressure on prices.

Isabel Schnabel, an ECB executive board member, told the Financial Times: “We must be patient and cautious because we know, also from historical experience, that inflation can flare up again.”

ECB chief economist Philip Lane said in a speech that recent data suggest disinflation “may run faster than previously expected”. But he also warned price pressures were expected to pick up as energy inflation stabilises, labour costs rise, demand recovers, and government support measures end.

He said: “We need to be further along in the disinflation process before we can be sufficiently confident that inflation will hit the target.”

Panetta dismissed fears that rapid wage growth — as workers try to recover the purchasing power they lost in the biggest surge of the cost of living for a generation — could cause a major rebound in inflation.

He pointed out that labour accounts for less than 40 per cent of total costs for the average eurozone company and any increase was likely to be offset by falling prices of intermediate goods and energy.

“A hypothetical increase in wage growth is currently highly unlikely to trigger a wage-price spiral,” he said.