Quick ECB Action to Rein in Inflation Could Crash Economy -Panetta

FRANKFURT (Reuters) -Growth rates in the euro zone could dip into negative territory this year and European Central Bank policy tightening to bring down high inflation in the near term risks crashing the economy, ECB board member Fabio Panetta said on Wednesday.

With euro zone inflation at a record-high 7.5%, the ECB is increasingly coming under pressure to tighten policy, even if the bulk of rapid price growth is due to high energy prices, which are largely outside the bank’s control.

Instead, Panetta said European governments should help the most vulnerable households and jointly finance what is likely to be a costly transition away from Russian energy.

“Quarter-on-quarter growth rates will be very low this year,” Panetta said in a speech. “The adverse impact of the war could well bring them into negative territory and produce longer-lasting effects.”

Panetta argued that oil and gas prices will stay high for longer and food prices could also increase more, so it would be quite costly for the ECB to bring down current inflation while medium-term expectations remain around its target.

“We would instead have to massively suppress domestic demand to bring down inflation,” he said. “In practice, we would have to amplify the ongoing sacrifice in real income suffered by the European economy.”

Tax cuts and subsidies could help in the short term, while joint borrowing and spending by European Union governments could be the longer term solution.

Germany has long frowned upon the idea of joint borrowing but agreed to the one-off, 750 billion euro Next Generation EU scheme, aimed at speeding the bloc’s recovery from the COVID-19 pandemic.

Panetta argued that the green transition and increased defence spending are the types of investments where centralised fiscal responsibility would outweigh the costs.

“If the responsibility for higher investment and the associated costs were to fall exclusively on the shoulders of the individual member states, it could lead – depending on the country – to underinvestment or a narrowing of fiscal space,” he said.

For its part, the ECB needs to watch whether high inflation risked raising or “de-anchoring” inflation expectations but there is no evidence of such second-round effects for now, Panetta added.

(Reporting by Balazs Koranyi; Editing by Hugh Lawson and Catherine Evans)