The ECB must be careful not to hike too much and crush inflation expectations, the Bank of Italy's governor says.
The European Central Bank could already be at or close to its neutral rate, and should continue hiking with care but only for so long as inflation expectations continue to call for tightening, Bank of Italy Governor Ignazio Visco said in a speech this Friday in Florence.
The neutral rate of interest is somewhere between 0.7% and 1.8%, Visco said, adding that the terminal rate of interest should be found by “proceeding gradually”. High uncertainty calls for prudence in setting future hikes, with a meeting-by-meeting approach based on last available data.
“[Decisions] will have to maintain a far-sighted orientation, based on the medium-term economic outlook,” said Visco, warned of the effect that large hikes can have in lowering inflation expectations.
While current inflation mainly caused by energy prices cannot be wholly curbed by monetary policy, the ECB can reassure households and businesses that it is determined to bring inflation down and anchor expectations.
There is also a danger that a worsening economic outlook and “excessively fast” hiking prompt a recession, making it harder to provide price stability in the medium term. (See MNI SOURCES: More ECB Policymakers See Restrictive Rates)
“In the euro area a rate hike exerts its largest effect on inflation after one or two years; however, it also has its largest impact on GDP growth after about a year and a half,” Visco said.