The The Governor's Governor's
Concluding Concluding Remarks Remarks
Annual Annual Report Report
Rome, 31 May 2023
year
financial
129th
th
Year
129
2022
Financial
The Governor's
Concluding Remarks
Annual Report
2022 - 129th Financial Year
Rome, 31 May 2023

Ladies and Gentlemen,
Russia's invasion of Ukraine continues to have heavy repercussions on the
global economy, calling into question international economic and financial
integration and the multilateral world order that took shape after the end of
the Cold War. A return to the tensions and divisions between opposing blocs
of countries poses a real threat to the sustainable and balanced development of
all economies. As well as condemning the blatant violation of the sovereignty
and territorial integrity of a free nation, it is essential, in spite of everything,
to pursue international cooperation strongly, including in the economic and
financial fields, and to seek dialogue that embraces the diversity of values
across countries and cultures in keeping with the basic principles of peaceful
coexistence.
The Italian economy has demonstrated a reassuring capacity to react to the
consequences of the war in Ukraine, just as it did when exiting the pandemic.
Corporate restructuring processes over the last ten years, although incomplete
and uneven across sectors and regions, have made our production system
more robust. The acceleration of capital accumulation, the improvement in
productivity after a long period of stagnation, and the recovery of international
competitiveness are all encouraging signs that need to become stronger, in
order to overcome the delays and underlying weaknesses that still prevent
our economy from unlocking its full potential. Our ability to return to a less
uncertain and more balanced structural growth path will depend on how well
we are able to tackle climate change and the digital transition, and to deliver on
the ongoing reform process.
The international environment
In 2022, global economic growth remained below 3.5 per cent, 1 percentage
point less than expected on the eve of the outbreak of war. According to the
International Monetary Fund (IMF), it is unlikely to reach 3 per cent this
year (Figure 1). Inflation almost touched 9 per cent globally; in the advanced
countries, it exceeded 7 per cent on average, the highest value for 40 years.
In some economies, and particularly in the United States, the acceleration
in prices was largely driven by a sharp rebound in consumption that began
in 2021, while supply was still constrained by pandemic-related restrictions
and, as regards international trade, by the resulting bottlenecks in the supply
of commodities and intermediate inputs (Figure 2). In Europe, by contrast,
inflation was fuelled mainly by higher energy prices, especially natural gas
prices, which soared to unprecedented levels.
After hovering around €20 per megawatt hour in early 2021, gas prices later
edged up, accelerating over the summer, and exceeded €100 on average at the end
of the year. This increase was due to the cuts in gas supplies from Russia, initially
on account of the weather conditions, and later mostly as a means of political
pressure in connection with the controversial opening of the Nord Stream 2
pipeline. With the outbreak of war, gas prices started to fluctuate dramatically,
peaking at €350 in the summer of 2022, when all European countries were
trying to replenish their stocks to secure minimum supplies for the winter. On
average over the year, gas prices were more than six times higher in Europe than
in the United States. A mild winter season, lower gas consumption following
price increases, governments' saving measures, and the fulfilment of gas storage
targets all combined to bring prices down to below €30.
The growth outlook for the world economy remains uncertain for the
coming months. It is burdened by the ongoing conflict in Ukraine, as well
as by doubts about the strength of the economic recovery in China after it
decided to lift its severe pandemic restrictions at the end of last year. Along with
energy prices, inflation is now falling both in Europe and in the United States.
However, its core component, i.e. excluding food and energy, is still high and,
for the time being, monetary policies remain tight to keep price growth under
control over the medium term. The effects of these policies, which have been
deployed almost simultaneously in all the main countries, may be compounded
by risks of instability in the global financial system.
These risks materialized last March with the failures of a number of banks
in the United States and Switzerland, which led to a sharp increase in market
volatility and significant portfolio reallocations. These tensions have largely
ebbed away, also thanks to the firm and timely response of the authorities
in those countries. However, financial bond yields in the advanced markets
remain significantly higher than in early March, as opposed to corporate bond
yields.
The fallout of global tensions, weaker growth and tighter financial
conditions is felt more strongly in the emerging and developing economies.
The public finances, already burdened by the increase in the debt as a result of
the pandemic, are more vulnerable. Around one fourth of emerging countries
are currently regarded as high-risk by the IMF, as their sovereign spreads are
now close to default levels.
Even beyond the short term, uncertainty still abounds. In recent decades,
cross-border trade and the organization of production on a global scale have
made for a more efficient allocation of inputs. However, the pandemic has
exposed the vulnerability of complex international supply chains, with
potential sudden disruptions in intermediate input flows originating from
critical hubs. The war in Ukraine and the subsequent energy crisis have made
these weaknesses even clearer; several countries, not only in the advanced
world, have embarked on policies to limit these disruptions.
Rifts in international relations can have long-lasting effects and influence
long-term business strategies, including manufacturing location decisions.
Since the invasion of Ukraine, business surveys, both in Italy and abroad, show
that a trend, though still moderate, is underway towards the regionalization
and diversification of supply chains. In Italy at least, this trend is stronger
among the firms more exposed to China.
Public policies too should aim to protect and diversify the sourcing of
commodities and essential intermediate inputs, though this kind of adjustment
will take time and entail costs that cannot be ignored. It is hampered by the
geographical distribution of primary resources and, at least in the short term,
by the high level of specialization of certain production processes. This goal
should be pursued without calling into question the foundations of a world
order that is based on common rules and open to the movement of goods,
services, capital, people and ideas.
National security can be protected by steering clear of broad-based
protectionism, which would reinforce the trend of rising barriers to trade and
foreign direct investment that has emerged over the last five years (Figure 3).
Not only would indiscriminate use of subsidies and restrictions in international
trade distort competition in an attempt to influence firms' location decisions,
it could also spark new tensions, including in relations between countries
sharing similar values, institutions and policies. In some cases, protectionist
measures may even prove detrimental to the goal of increasing geographical
diversification in sourcing.
Over the past three decades, cross-border trade has made a fundamental
contribution to the general and economic well-being of a large part of the
world's population. The number of people living in extreme poverty has fallen
from almost 2 billion to less than 700 million; the share of the population
suffering from malnutrition has dropped from over 25 per cent to below 15
per cent in the developing countries. Meanwhile, there has been a dramatic
improvement in literacy and an extension of life expectancy of more than ten
years on average.
The improvements were more palpable for those economies that were
fully integrated into global trade and global value chains over this period.
Instead, some countries, mainly in Sub-Saharan Africa, where most of the
projected demographic expansion in the coming decades is concentrated,
have only benefited marginally. In recent years, the explosion of regional
conflicts, the increased frequency of natural disasters and the pandemic have
held back progress.
Globalization and the technological innovation that has expedited it
have therefore created an extraordinary opportunity for development. In the
advanced countries, however, the result has been less employment stability
and, in some cases, greater inequality, which has not been properly addressed
by public policies. A growing sense of insecurity and injustice has thus crept
in among large sections of the population, whose incomes have struggled
to increase. This feeling has been exacerbated by the continuous rise in the
incomes of the population segment that is already much richer, particularly
in English-speaking countries. Partly as a result of this, public opinion has
become increasingly critical of opening up to international trade.
It would be a mistake to underestimate the benefits of market integration,
especially for an open economy like ours. Nor can we forget that the challenges
we need to address today - from combating climate change to countering
pandemic threats, from reducing poverty to managing migrant flows - are
global in nature and can only be solved through orchestrated efforts worldwide.
Externally, it is therefore necessary to preserve the functioning of multilateral
institutions and reinforce international cooperation. Internally, however, it is
crucial to introduce economic measures that can actually improve the
wellbeing of all citizens, as well as to communicate them effectively in terms of
tools and targets.
European policies show that confidence in the benefits of international
economic integration can indeed be strengthened. According to Eurobarometer
surveys, public support for Europe's integration process, which worsened in
the decade preceding the vote on the United Kingdom's exit from the European
Union, has grown again in recent years (Figure 4). This has also reflected the
measures taken to support the post-pandemic recovery, particularly the Next
Generation EU (NGEU) programme.
The economic situation and monetary policy in the euro area
The effects of the conflict in Ukraine on the euro-area economy have
been amplified by the marked dependence of many Member States on energy
imports, especially natural gas. The rises in their prices, together with those of
agricultural products, also mainly caused by the war, have affected households'
purchasing power, above all of the less well-off, and firms' production costs. Yet
if we look at 2022 as a whole, aggregate demand, production and employment
continued in the recovery that began when the most acute phase of the
pandemic emergency was over and that was supported by the considerable
resources allocated by national governments and by the European Union.
Since last autumn, however, economic activity has stagnated overall.
Consumer price inflation has risen to 8.4 per cent on average over the
year, reaching a peak of 10.6 per cent in the twelve months up to October
(Figure 5). The increases in commodity prices have gradually passed through
to the prices of other goods and services. More than three quarters of the
growth in the overall consumer price index seems to be directly or indirectly
attributable to the higher prices of energy and of food products. The delays
in adapting the global supply of intermediate goods have contributed to the
increase in production costs.
Headline inflation has fallen since the final part of 2022, thanks to the
sharp drop in energy costs, going down to 7 per cent in the spring of this year,
but core inflation has continued to rise, standing at 5.6 per cent in April. This
component includes items whose prices are reviewed less frequently; it is still
responding, with some delay, to the higher prices of imported commodities,
and it is expected to reflect their reduction in an equally gradual way.
In 2022, wage pressures in the euro area remained limited overall: the
growth in actual hourly pay stood at just over 3.5 per cent, thus remaining
well below inflation. Requests for high salary increases have become more
frequent recently, sometimes in tandem with a high level of conflict, especially
in countries with lower unemployment. Thanks to the limited presence of
automatic wage indexation mechanisms based on past inflation and to the
one-off nature of a large part of wage increases, and with no widespread rises in
profit margins, the risk of a wage-price spiral has remained low up until now.
According to the latest projections, following an increase of 3.5 per cent
in 2022, economic activity in the euro area will slow down considerably on
average this year, and will then return to sustained growth. Inflation will come
down over the next few months, reflecting above all the trend in the prices of
energy products; in the scenario drawn up in March by the European Central
Bank (ECB), currently being updated, it is projected to return to 2 per cent
in the second half of 2025. The margin of uncertainty remains high.
In line with the resolve to bring inflation back fairly rapidly to the
target of 2 per cent, at the beginning of May, the ECB Governing Council
confirmed its restrictive measures, though limiting the increase in the key
interest rates to 25 basis points. The interest rate applied to deposits that banks
hold with the Eurosystem rose from the negative levels recorded last July to
3.25 per cent. The Council reiterated that future decisions will continue to
be guided, on a meeting-by-meeting basis, by an overall assessment of the
medium-term inflation outlook in light of new economic and financial data,
the performance of the core component and the intensity of monetary policy
transmission to the economy.
Leverage on key interest rates is still the main element for defining the
monetary policy stance. To ensure full alignment with this stance, there was
a more rapid repayment of the long-term refinancing provided to banks and
a measured and predictable decrease in the assets held in the Eurosystem's
monetary policy portfolios was begun last March.
The response of the Governing Council to the acceleration in prices
has been fully in line with the gradual changes in the situation and in the
data as they have become available. It should be remembered that, in June
2021, despite the rises in natural gas prices and the bottlenecks in the supply
of intermediate products, headline inflation in the euro area had still not
reached 2 per cent and core inflation was below 1 per cent. In the same
period, inflation was around 5 per cent in the United States, largely due to
the recovery in demand linked to the strong stimulus of fiscal policy. Not
even the markets were signalling expectations of a prolonged acceleration
in prices: in the euro area, the two-year inflation expectations derived from
inflation-linked swaps equalled 1.5 per cent, compared with almost double
that figure in the United States.
The subsequent increase in euro-area inflation, which was extraordinary
and mostly unexpected, was caused above all by the equally exceptional
leap in energy prices. The extensive forecasting mistakes made by ECB and
Eurosystem staff, and by almost all analysts, were mainly attributable to the
general underestimation of the effects of geopolitical changes. At the end of
2021, when we announced the start of the monetary normalization process,
which immediately led to a sharp rise in long-term interest rates, market prices
continued to indicate expectations of a marked fall in gas prices (Figure 6).
The Russian aggression against Ukraine transformed a temporary
price shock into something far more intense and persistent. Despite all the
uncertainties connected with the conflict, monetary normalization was swift.
The termination of net purchases of financial assets was brought forward to the
end of June. A resolute process was begun immediately afterwards to raise the
key interest rates from the highly accommodative levels set in previous years
to successfully counter the risk of deflation. In order to ensure that monetary
policy is transmitted as evenly as possible across euro-area countries, it was
decided to reinvest the securities purchased under the pandemic emergency
programme in a flexible manner, and the new Transmission Protection
Instrument (TPI), aimed at mitigating the risks of fragmentation of financial
conditions, was introduced.
Market yields have adapted quickly to the altered monetary policy
stance. Since the start of the normalization process, one-year risk-free interest
rates have picked up from barely negative levels to the current 3.7 per cent,
while those at ten years have come from barely positive levels to 2.9 per cent
(Figure 7). The effectiveness of the Governing Council's actions is confirmed
by the changes in inflation expectations, which are an important anchor for
firms' decisions on prices and for wage growth. Having reached almost 9 per
cent at the end of August 2022, market expectations over a twelve-month
horizon now stand at just below 3 per cent; signs of a fall in expectations
are also emerging from surveys conducted on firms and households.
Longerterm expectations, which are a measure of a central bank's credibility, remain
in line with the definition of price stability, while the risk of inflation being
higher than the target for too long has gone down considerably compared
with the peak of mid-2022 (Figure 8).
Monetary tightening also affects credit dynamics. The cost of bank
loans is rising sharply; the surveys of credit institutions and firms point to a
marked reduction in demand and to much tighter credit access conditions.
Having risen to almost 13 per cent (on an annual basis) in the three months
ending in August 2022, the growth in loans to non-financial corporations
in the euro area has recently come to a halt; this trend also concerns loans
to households, albeit to a lesser extent. Although these developments are a
necessary consequence of monetary normalization, care must be taken to
prevent the intensity of its transmission from causing an excessive brake on
consumption and investment.
This is a tough challenge. The shock caused by the higher energy prices
renders it necessary to search for a balance between the risk of insufficient
tightening, which could lead to inflation becoming rooted in expectations
and in processes for determining nominal income, and the risk of a
disproportionate tightening, which could have overly acute repercussions for
economic activity, and negative effects on financial stability and, ultimately,
on medium-term price stability.
The monetary policy stance must continue to be defined so as to guarantee
a gradual, though not slow, return of inflation towards the target. The pace
and the range of the adjustment of monetary conditions have already been
unprecedented, just as the deflationary pressures of past years and the risks
linked to the pandemic had been, which had pushed us to take the key interest
rates into negative territory, and then keep them there. The impact of our
decisions on the economy and on prices should fully unfold over the next few
months; after bringing the reference rates to restrictive levels, we now have to
proceed with the right degree of graduality.
As I have observed on more than one occasion, the rise in energy prices
is in actual fact an unavoidable tax for the euro-area economy. The return
of inflation to levels in line with the target will be faster and less costly if
everyone - firms, workers and governments - contributes to this goal, thereby
improving the effectiveness of an indispensable, though balanced, monetary
normalization. Firms' price strategies will play a fundamental role: just as in
the phase when energy prices rose in 2022, the recent cost reductions should
now be passed through to the prices of goods and services.
A purely retrospective approach to labour market bargaining is to
be avoided, as wage dynamics replicating those of past inflation would
only translate into a futile wage-price spiral. A more sustained growth in
productivity is instead needed to restore purchasing power. Any fiscal
measures will have to be temporary and targeted; these interventions must
be promptly removed when they are no longer indispensable, both because
returning to the price stability target would be more difficult in the event of
excessive public transfers and in order to not hinder the necessary transition
to renewable energy sources.
The architecture of the economic and monetary union
The last few years have been of great significance for the prospects of the
European Union. Above all, the importance of having a fully-fledged common
economic policy, in addition to the single monetary policy, has come to the
fore. However, we need to make further substantial progress to complete the
journey we embarked on when we adopted the euro.
During the difficult years of the sovereign debt crisis, the incompleteness
of the monetary union and the inadequate economic governance had fuelled
pervasive mistrust in the future of the euro. Those difficulties spurred the debate
on the need to move towards greater integration. However, the major reforms
outlined at that time, and in some cases initiated, lost momentum: the banking
union is still incomplete, the capital markets union is still at a very early stage
and no progress has been made towards achieving a fully-fledged fiscal union.
Only the most recent and serious emergencies have helped us to overcome
doubts and hesitations in a decisive way. The European policy response to the
pandemic crisis has been strong and swift. As well as the massive coordinated
efforts made to contain the spread of the virus and to purchase and distribute
vaccines among countries, the European Union has used innovative
instruments at a strictly economic level too: member countries were granted
loans to mitigate unemployment risks, and the NGEU programme has made
substantial resources available to national budgets to finance investments
and reforms to support the economic recovery and for the twin green and
digital transitions. There has also been a cohesive response to the energy crisis,
including by integrating the REPowerEU plans, aimed at reducing energy
dependency on Russia, into national NGEU plans.
These measures are extremely important, not only because of their
magnitude, but above all because they testify to the ability of EU institutions and
Member States to assume shared responsibilities to face common challenges,
first and foremost in the interest of future generations. However, despite having
inherently structural effects, these measures are mostly temporary.
If the national measures financed by these programmes are successful,
they could be the first steps towards a fully integrated economic union. Aside
from having an unprecedented opportunity to tackle long-lasting problems,
the countries that benefit most from these resources - first and foremost
Italy - must also demonstrate the real usefulness of such greater integration,
providing tangible results.
At the same time, however, we need to be aware that to complete the
European project we must first overcome major institutional and political
hurdles. An essential requirement for this lies in a renewed and firm
commitment by all Member States to seeking common solutions to common
problems. We need to increase and, on certain matters, restore trust between
European citizens, keep the political dialogue alive and constructive, and
reduce the seemingly widespread mistrust of the EU institutions.
As for fiscal policies, the reform should rest on two key pillars: rethinking
the rules and building an effective fiscal capacity, backed by own resources and,
when necessary, by issuing debt. On the former pillar, a major step forward was
taken with the presentation of the European Commission's reform proposal
in April, a proposal that goes in the right direction. It focuses on
mediumterm fiscal sustainability and long-term economic growth, while making the
rules less complex and more credible by involving national authorities in the
fine-tuning process.
The Commission's proposal may not meet the expectations of all member
countries, for various reasons. The goodwill of all is needed to find a viable
and shared solution. The rules must be applied to a world that is marked
by intricate interdependencies and unexpected shocks, where national fiscal
outcomes cannot be assessed out of context. Yet compliance with the fiscal
rules and their credibility are in the interest not only of the Union as a whole,
but also of each of its countries. They are crucial for Italy, aiming to reduce
its overly high public debt over time, and consistent with the fiscal discipline
recognized as necessary by our Constitution.
The introduction of a supranational fiscal capacity, which is missing in
the Commission's reform proposal, would make it possible to manage both
country-specific shocks and common adverse events, such as the pandemic
and the energy crisis, more efficiently. If the current institutional and political
challenges make it difficult to achieve a fully-fledged fiscal union in the
near future, we could build on the tools put in place during the pandemic
emergency pragmatically, for example by designing forms of joint financing
for automatic stabilizers, as we did with the borrowing scheme for the
measures to mitigate unemployment risks. To ensure that some European
public goods - such as those in the digital, energy, environment and security
sectors - are delivered in adequate amounts, we should devise instruments
similar to those under the NGEU programme.
The shocks that hit the European economy have left a burdensome
legacy in terms of public debt. We must prevent it from becoming the cause
of new crises. Wide and long-lasting spreads between the bond yields of the
various EU Member States hamper economic convergence. As postulated by
numerous proposals in recent years, the management at European level of
part of the liabilities already issued by each Member State, with adequate
safeguards to avoid systematic cross-border transfers of resources, would give
the monetary union greater stability.
Furthermore, as has been suggested on several occasions, a common
public debt security, to be issued in connection with the functioning of
the European fiscal capacity or determined by sharing part of the national
liabilities, could act as a safe asset, typically attributed to government bonds
in the other main economies, and could support reforms designed to bring
the capital markets union to life. On this front, the proposals put forward
by the Commission at the end of last year and the ongoing discussions - on
insolvency law, listing of firms, especially smaller ones, financial markets
and central counterparties - are heading in the right direction. However,
we need to move fast to ensure that the European capital market can best
contribute to the financial effort needed to successfully tackle the climate
and digital innovation challenges, against a backdrop of enhanced financial
stability.
Lastly, the importance of completing the banking union cannot be
ignored, by revising the current crisis management framework to make it
faster and more effective, and by establishing a single deposit guarantee
scheme. The recent episodes of instability outside the European Union clearly
show the importance of achieving these goals. As soon as its reform is fully
operational, the European Stability Mechanism - thanks to the resources at
its disposal - will be able to play a key role by providing a backstop to the
Single Resolution Fund.
The stability of the financial sector
The crises that have broken out in the United States and Switzerland
serve to remind us that banking is an inherently risky business and that it is
not possible to reduce the probability that a bank failure will occur to zero.
The role of institutions, regulatory and supervisory authorities is to lower this
probability as much as possible, by defining the rules and imposing safeguards.
It is critical, when managing crises, to have appropriate tools available to limit
their impact on and costs to society and to prevent isolated events from turning
into systemic ones, with ripple effects on the economic and social outlook.
In the US regional banking sector, the business models of the banks
that were hit displayed serious weaknesses, with an excessive interest rate
risk exposure and highly concentrated funding skewed towards large, and
therefore uninsured, customer deposits. Poor corporate governance played
a crucial role in these crises. Other factors likely contributed, including the
failure to fully apply international regulatory standards to banks deemed
non-systemic, lapses in supervision, the speed with which fears about the
banks' solvency spreads through digital channels and the ease with which new
technologies allow depositors to transfer funds.
In the European Union banking system, in part thanks to stricter
regulations and a supervisory approach that focuses on business model
sustainability, no signs of situations akin to those in the US have emerged.
However, market turbulence serves as a warning of how quickly investor
confidence can crumble and, as a result, how the risks to financial stability
should never be underestimated. Rather, it underscores the need for a prudent,
data-dependent monetary policy.
Italy, like the other euro-area countries, has not witnessed unusual
outflows of deposits. Since July of last year, when deposits peaked at almost
€1,620 billion, this source of funding has fallen by 6 per cent, reflecting
the natural reduction in the liquidity accumulated during the pandemic and
customers' pursuit of higher-yield investments, better able to shield savings
from inflation. The reduction in deposits has had a modest impact on the
liquidity coverage ratio and the net stable funding ratio, which remain well
above the regulatory minimum requirements.
Rising interest rates have caused the value of portfolio securities to fall.
The unrealized losses on those securities that banks plan to hold until maturity
(booked at amortized cost), estimated to have an average impact of 200 basis
point on the CET1 ratio, would only materialize if banks were compelled to
sell them before maturity. Less than 2 per cent of these unrealized losses are
currently accounted for by banks with a relatively low liquidity coverage ratio.
More generally, the well-developed mechanism that regulates the use of central
bank asset-backed refinancing in the euro area helps to lower the probability
that banks will have to liquidate their portfolio securities before maturity.
Overall, the banking system is in a sufficiently good position. Last year, all
the main balance sheet ratios were at satisfactory levels as a whole and in many
cases they have improved. The share of non-performing loans has remained
stable, at low levels and in line with the European average. Profitability, long
compressed by low interest rates and high credit losses, has risen significantly,
benefiting from the increase in net interest income. The capital position has
also slightly improved.
Yet uncertainty about the economic outlook warrants caution. We expect
the cyclical slowdown and tighter credit standards to cause credit quality to
deteriorate, which would have an impact on loan loss provisions, still low at
the moment. Adjusting the interest rates paid to customers will cause funding
costs to increase. The shift towards more expensive sources of funding as the
third series of targeted longer-term refinancing operations gradually reach
maturity, and as banks are required to comply with resolution requirements,
is also expected to contribute to this increase.
The stability of the Italian banking system is the result of an intense
decade-long process of cleaning up balance sheets, improving efficiency, and
strengthening corporate governance and internal controls. It is a result that
many observers, including authoritative ones, had doubted could be achieved.
It was not, however, without its challenges. More than a few times, prompt
intervention has made it possible to overcome fragilities