Italy’s central bank faces a turning point

Difficult road ahead for new Banca d’Italia governor

Italy has a new governor at the helm of its central bank. The event deserves more attention than it elicits. True, the Banca d’Italia has lost most of its powers to the European Central Bank in the last quarter-century. But as the country’s most respected economic technocracy, its persuasion and guidance can still play a key role at a juncture that may evolve into one of the most critical and dangerous in the nation’s recent history.

The appointment of Fabio Panetta ends the double six-year tenure of Ignazio Visco, a respected economist who unexpectedly found himself in the governor’s seat following the departure of Mario Draghi, who became ECB president in November 2011.

Visco’s mandate wasn’t easy. He presided over momentous events like the loss of banking supervision to Frankfurt, high-profile banking failures (partly attributed to earlier supervisory mistakes of the bank) and unprecedented pandemic and inflationary shocks, all handled in co-operation with eight different prime ministers of the most diverse political hues.

Perhaps because of those troubled circumstances, Visco’s governorship didn’t shine. The institution under his purview did not enjoy the migration of bank oversight to the ECB, occasionally expressing reservation about the latter’s proactive supervisory stance.

Farsightedly, the bank supported Draghi’s ‘whatever it takes’ moment in 2012 and his subsequent policies against deflation. But it spectacularly failed to see inflation coming in the early 2020s, taking ultra-dovish positions even after it was clear that price stability was in jeopardy according to all meaningful definitions.

Its defence of fiscal caution sounded feeble while the country’s debt-to-gross domestic product ratio was rising to 144% in 2022 from 134% in 2019, and again recently when the government announced significant upward revisions of public debt and deficit goals for this year and the next.

Those past challenges pale compared to what the future may hold. The country’s economic and financial prospects look increasingly testing. Headline inflation, after peaking at around 12% a year ago, fell sharply in October. But with core consumer price index growth still over 4%, it is too early to declare the battle won.

Public finance, the mother of all Italian problems, is in a worrisome state. The coalition, headed by Prime Minister Giorgia Meloni and including forces that have always been reluctant to endorse fiscal caution and Europe’s budget surveillance, has relaxed its fiscal targets. The debt-to-GDP ratio is likely to start heading up again, contrary to official projections. The spread of Italian 10-year bonds over the corresponding German paper hovers around 200 basis points. Unprecedentedly, the Italian state now pays investors over 50 basis points more than Greece does.

Another hurdle not to lose sight of is the Italian banks. The largest ones have improved markedly in the last decade, partly as a result of relentless supervisory pressure by the ECB. But there remain weak spots among the small and medium-sized ones. The combination of a stagnating economy and rising public debt may interact viciously with the weakest part of the banking sector, reigniting the ‘doom loop’ that nearly brought Italy down in 2011.

Panetta, the seasoned central banker that Meloni appointed to succeed Visco, has solid professional credentials and experience. A long-time Banca d’Italia insider, he was intimately involved in all past decisions, both good and dubious. But now he has the opportunity to make a fresh start. How he handles this will define his tenure.

The bank needs to build new and solid alliances in the ECB decision-making governing council, along a careful but unambiguously anti-inflationary monetary line. It needs to convince the government to put debt consolidation above all other priorities, putting aside overly ambitious tax reduction plans.

Italy must accept a quantum of binding European surveillance on its public debt as part of the negotiation on the reform of the Stability and Growth Pact. It must ratify as a matter of urgency the reform of the European Stability Mechanism, which gives financial assistance to indebted states, a reform so far blocked by Italy alone. Last and not least, the central bank should work to strengthen the credit sector further, in close co-operation with European authorities.

All these steps are clearly in Italy’s interest. Undertaken convincingly and in combination, they can ward off the clouds that gather on the economic horizon. The new Banca d’Italia governor can exercise a key influence in promoting that agenda. Let’s hope he will.

Ignazio Angeloni is part-time Professor at the Robert Schuman Center, European University Institute, Senior Policy Fellow, SAFE, Goethe University Frankfurt and a former member of the European Central Bank Supervisory Board.

Image source: European Central Bank

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