ECB’s Rehn: Should Hike Deposit Rate to -0.25% in July and to Zero in the Autumn

25 May 2022

By David Barwick – FRANKFURT (Econostream) – The European Central Bank should hike its deposit facility rate by 25 basis points in July and then by another 25 bps in the autumn, Governing Council member Olli Rehn said on Wednesday.

In a speech at a payments forum, Rehn, who heads the Bank of Finland, said that euro area wage growth had been ‘relatively subdued so far, but is projected to accelerate somewhat this year’, though in contrast to the US, the labour market here was still getting over the pandemic.

This was an example of ‘cross-cutting pressures on monetary policy, which needs to take into account the factors contributing to the sharp acceleration in inflation, as well as possible factors related to the rapid deceleration in growth’, he said. ‘The situation is not easy, but the Governing Council has the necessary monetary policy instruments at its disposal to stabilize the situation.’

Overall, ‘it would be justified to continue the normalisation of monetary policy by raising the deposit rate from the current -0.50% to -0.25% in July and further to zero in the autumn’, he said. ‘However, there is considerable uncertainty about the economic situation, especially with regard to the war of aggression in Russia and its effects.’

Monetary policy normalisation would be gradual and the increase in official borrowing costs to zero does not imply policy tightening, he argued.

Rehn predicted that the ECB staff forecasts to be released in June ‘will need to be updated in a weaker direction.’

‘Russia's offensive war has significantly increased inflationary uncertainty, and upside risks to inflation have increased’, he said. ‘However, according to the spring-winter forecast, it is possible that inflation could slow to close to the ECB's 2% target in the coming years, depending in particular on energy and commodity prices.’

‘Critical to monetary policy is whether rising energy and commodity prices affect wages, inflation expectations and firms' pricing behaviour’, he said. ‘In order to avoid wage and price volatility, it is particularly important to curb inflation expectations, which have risen this year. The various measures of inflation expectations are currently above 2% overall, but in the medium term they are still quite close to that level. However, accelerated energy inflation alone will not automatically lead to persistent rapid inflation, unless it causes significant multiplier effects, ie price and wage fluctuations.’