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FRANKFURT: The European Central Bank (ECB) will likely raise interest rates to preserve credibility in the face of a war-driven rise in fuel costs but there is little to suggest yet that high inflation is taking root in the eurozone, ECB policymaker Olli Rehn says.
The ECB is all but certain to increase borrowing costs at its meeting on June 11 after disruptions to the Strait of Hormuz caused a spike in oil prices and pushed inflation in the eurozone above the bank’s 2% target.
Rehn, Finland’s central bank governor, echoed several of his colleagues in saying the eurozone was sliding towards the ECB’s “adverse scenario” of slower growth and higher inflation, which may force it to raise rates “for the sake of credibility”.
But he said that the price of gas had not risen as much, wage growth was still moderating and longer-term inflation expectations were still anchored at 2% despite a rise at a shorter horizon.
“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 things, we see vibration in the short-term inflation expectations, but no significant deviation in medium- to long-term inflation expectations.”
He said the decision next month will also be informed by the ECB’s new economic projections and any any development about a ceasefire between United States and Iran.
Sources told Reuters the case for a June hike was nearly sealed but that the bank was unlikely to commit to future rises.
Financial markets expect one or two further moves in the following 12 months, leaving the rate the ECB pays on bank deposits at 2.5% to 2.75%.
Rehn argued the situation in Iran would either morph into a prolonged conflict that would further hamper energy supply to the eurozone, or de-escalate in a ceasefire in which the Strait of Hormuz is reopened.
“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.
This meant coming up with “Plan B,” led by European Commission, for sourcing jet fuel and other products that currently come via the Gulf while the economy adjusts.
Governments should avoid stimulating demand for fuel with overly generous subsidies, as the fiscal space to do so is limited.
He noted northern European countries, France and the Iberian Peninsula would be partly shielded from the energy shock by a greater reliance on nuclear and renewable energy, with Germany, Italy and central Europe hit harder. — Reuters
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