European Central Bank Governing Council member and Bank of Italy Governor Fabio Panetta stated on Tuesday that despite progress in US-Iran talks toward a lasting peace agreement, the ECB still faces an uncertain economic landscape. He emphasized the need for monetary policy to remain adaptable to address various uncertainties.
Speaking at a conference in Rome, Panetta noted that while negotiations between the US and Iran could lead to energy prices lower than the ECB's June projections, "the outlook remains fragile." He stated, "Upside risks to inflation coexist with downside risks to growth. This requires us to continuously monitor geopolitical dynamics, energy markets, supply chains, wage levels, and inflation expectations. At the same time, monetary policy should avoid committing to a predetermined path."
The ECB raised interest rates last month, which Panetta described as a "recalibration," following a surge in oil prices that pushed inflation higher and increased the risk of runaway price expectations. Most economists and financial markets anticipate one more rate hike from the ECB this year, although some officials question whether further increases are necessary.
Panetta remarked that the current conflict is one of a series of more significant supply shocks that could alter how policymakers combat inflation in the future to achieve the 2% target over the medium term. He said, "These shocks are becoming more frequent, more persistent, and more intertwined with transformations in the global economic structure. In this rapidly changing environment, central banks must continuously improve their ability to interpret shocks, assess transmission mechanisms, and make decisions under uncertainty."
He added that geopolitical fragmentation, artificial intelligence, demographic aging, and climate change are reshaping the global landscape, and monetary policy must adapt accordingly. "Central banks are not the primary actors to resolve these tensions, but they must understand how structural factors affect the economy and the transmission of monetary policy," Panetta stated.
Panetta argued that a textbook approach viewing the situation merely through the lens of a temporary supply shock underestimates the "scale and possible duration" of the crisis. "Global energy supply has suffered a massive blow. Even if the conflict subsides, damage to production and transportation infrastructure could affect prices," he said, adding that the management of the Strait of Hormuz remains uncertain.
Simultaneously, Panetta pointed out that the current situation is not a repeat of 2022, when soaring energy prices drove inflation above 10%, forcing the ECB into aggressive tightening. He noted that current demand is weak, real interest rates are higher, and this shock impacts oil more than natural gas.
Diverging Views Within ECB, Rate Hike Expectations Cool
ECB Executive Board member Isabel Schnabel indicated on Monday that peace efforts in the Middle East have led to a rapid decline in energy prices, but the global situation has not returned to pre-conflict conditions. She reiterated that the shock from the US-Iran conflict cannot be simply ignored, warning that pipeline and supply chain pressures remain elevated.
While officials like Schnabel insist that price pressures persist and could push up wages, food, and service costs in the coming months, falling oil prices and faster-than-expected easing of inflation have raised doubts about whether the ECB will hike rates beyond its June increase.
Following hints from some policymakers that the worst of the shock may be over, traders have reduced their bets on further ECB monetary tightening this year. National Bank of Belgium Governor Pierre Wunsch reiterated that while he does not rule out another rate hike, the current situation is clearly much calmer. "The shock seems to have dissipated, and based on market conditions, oil and gas prices could soon return to initial levels, possibly even lower," he said.
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