The European Central Bank could move to raise interest rates at its next policy meeting on June 11 to safeguard its credibility, but there is little evidence so far that a prolonged period of high inflation is taking hold across the euro area, ECB policymaker Olli Rehn said in an interview.
Rehn pointed to a recent spike in oil prices after disruptions in the Strait of Hormuz as a catalyst for the rise in consumer prices that pushed inflation above the ECB's 2% target. That shock, he said, has pushed the euro area closer to what the bank has described as an "adverse scenario" - namely slower growth accompanied by higher inflation - and could force the ECB to act "for the sake of credibility."
At the same time, Rehn emphasised that several indicators do not yet point to an entrenched inflationary process. He noted that gas prices had not increased as sharply as oil, wage growth was moderating, and longer-term inflation expectations remained anchored at 2 percent despite an uptick at shorter horizons.
"From the standpoint of medium-term orientation, the critical thing is whether we see evident signs of second-round effects, and/or de-anchoring of inflation expectations," he said. "If you look at those two things, we see some vibration in the short-term inflation expectations, but no significant deviation in medium- to long-term inflation expectations."
Near-term policy is being assessed against the backdrop of fresh economic projections that the bank will publish ahead of the June meeting, Rehn added. He also said any developments toward a ceasefire between the United States and Iran would be material for the decision-making process.
Financial market pricing shows an expectation that one or two more rate moves could follow, leaving the deposit facility rate in a range of 2.50 percent to 2.75 percent, according to market-implied projections cited in the discussion. Sources familiar with internal discussions indicated that the case for a June rate hike was nearly settled, although the bank was unlikely to commit to a sequence of future increases.
On the geopolitical front, Rehn said the situation involving Iran and the Strait of Hormuz presented two distinct paths. One outcome would be a prolonged conflict that further disrupts energy supplies to the euro area. The other would be a de-escalation leading to a ceasefire and the reopening of the strait. "If I had to put odds on those, I think it’s better that we prepare ourselves for a prolonged conflict, regrettably, and think about how to adjust and mitigate its effects, including maintaining our work on the green energy transition," he said.
Part of that preparedness, Rehn said, involves contingency planning - a "Plan B" led by the European Commission to source jet fuel and other petroleum-derived products currently supplied via the Gulf while the economy adjusts. He cautioned governments against using generous subsidies to stimulate fuel demand, arguing such measures would be ill-advised given limited fiscal space.
Rehn also pointed out that the energy shock will not be uniform across the euro area. Northern European countries, France and the Iberian Peninsula are likely to be partly insulated because of higher shares of nuclear and renewable generation. By contrast, Germany, Italy and parts of Central Europe would face more severe effects from higher energy prices.
"You have obviously quite different impacts of the energy price shock because of that," he said. "And that has an effect on monetary policy."
Taken together, Rehn's comments sketch a policymaking environment in which a prompt tightening in June is probable to preserve the bank's credibility amid an energy-driven price uptick, while persistent inflationary pressures remain unproven in medium-term indicators. The bank's next set of projections and any movement in the geopolitical situation will be central inputs to the decision on whether to act and how forcefully to proceed.