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The European Central Bank is likely to need extra interest rate cuts if global borrowing costs are pushed up by the US Federal Reserve maintaining its restrictive monetary policy stance, a top eurozone policymaker has said.
Fabio Panetta, head of Italy’s central bank, said in a speech on Thursday that if the Fed keeps rates on hold longer than markets expect, or even raises them, it would be “likely to reinforce the case for a rate cut [by the ECB] rather than weakening it”.
Panetta’s comments clash with warnings from other ECB rate-setters that they should avoid diverging too much from the Fed and underline how doubts over the direction of US monetary policy are creating tensions in Europe.
Investors have scaled back their bets on how many times the Fed will cut rates this year after its chair Jay Powell said borrowing costs would need to stay at 23-year highs for longer than anticipated because US inflation was proving stickier than forecast.
Some traders are now even pricing in rate rises by the Fed in the next 12 months.
The ECB has signalled it is highly likely to start cutting its benchmark deposit rate from an all-time high of 4 per cent at its next policy meeting on June 6 as long as price pressures keep fading in line with its forecasts.
But jitters about a tighter Fed stance have pushed up bond yields in Europe as investors scale back the number of ECB rate cuts they expect this year.
Panetta told an ECB event in Frankfurt that it was an “important question” to what extent the central bank’s policy could diverge from the Fed, and he warned of the dangers of failing to account for the “powerful spillovers” from the dominant US bond markets to those in the rest of the world.
“If markets expect interest rates to drop but the Fed keeps them unchanged — for instance on the back of strong inflation data — the rest of the world faces an unexpected monetary tightening,” he said. “A tightening in the US has a negative impact on inflation and output in the eurozone.”
He added that “downside risks to the outlook implies that the ECB should consider the possibility that monetary policy could become ‘too tight’ going forward”.
His comments were supported by estimates from French bank BNP Paribas that if European bond yields were driven half a percentage point higher by the fallout from US markets, it would require an extra 0.2 percentage point of rate cuts by the ECB to offset the impact of tighter financial conditions.
However, other members of the ECB’s rate-setting governing council have expressed concerns about committing to much more easing after June because of the risk that this would cause the euro to depreciate, thereby increasing inflation by pushing up import prices.
“I would definitely be in favour of a rate cut in June,” German central bank boss Joachim Nagel said on Wednesday. “However, such a step would not necessarily be followed by a series of rate cuts.”
Austria’s central bank head Robert Holzmann said: “I would find it difficult if we move too far away from the Fed.”
ECB vice-president Luis de Guindos told Le Monde this week that the central bank would “need to take the impact of exchange rate movements into account”.
He also said transatlantic divergence on rates could trigger higher “capital flows” from Europe to the US as well as increase risks for the banking sector.
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