ECB Insight: Rehn Sounds Hawkish, But Not Unreservedly So

16 January 2023

By David Barwick – FRANKFURT (Econostream) – At first glance, European Central Bank Governing Council member Olli Rehn’s comments on Monday appear to be hawkish. On a second look, a degree of reservation stands out.

In a column on the website of the Centre for Economic Policy Research (CEPR), Rehn, who heads the Bank of Finland, more or less echoed any number of his peers by writing that ‘[p]olicy rates will still have to rise significantly to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target.’

In a slight departure from standard ECB messaging of late, Rehn did not frame the further tightening in the context of a ‘steady pace’, though one can’t be sure that there is significance to the omission.

‘Thus, we will stay the course’, he continued. ‘Ceteris paribus, this means significant rate hikes in the following meetings – on a meeting-by-meeting basis depending on the incoming data and changes in the outlook.’

It’s his ‘ceteris paribus’, reinforced by ‘changes in the outlook’, that gives us pause. What things does he suspect might not be equal, i.e. turn out differently than currently projected?

Rehn doesn’t tell us, continuing instead with stock arguments for taking official borrowing costs into restrictive territory and then an expression of concern at the degree to which the area’s output is in the grip of powerful price pressures.

Hawkish, yes – new, not. The broad-based nature of inflation elicited the same degree of concern from him in a November 28 speech – ‘almost all goods and services’ then versus ‘virtually all products and services’ today.

Rehn doesn’t seem to have grown any more hawkish with respect to inflation expectations, either. Seven weeks ago, he commented that by some indications, these had ‘risen somewhat but are still in the proximity of 2%’, leading him to declare confidence in the ECB still ‘intact’. Today, he stated that ‘medium- and longer-term inflation expectations are still relatively well anchored’.

We find more interesting what he wrote following his reiteration of the benefits of restrictive monetary policy: ‘But the near term is shrouded in uncertainty, and we need to keep an open mind to adjust our policies if needed.’

This harks back to his ‘ceteris paribus’. In what direction does he think a policy adjustment likely enough to want to include such a reservation? To be sure, he continues with the observation that the combination of supply constraints and expansionary fiscal policies fosters inflation and ‘makes our job more demanding’, perhaps suggestive of unplumbed depths of hawkishness yet to come.

Supply constraints are hardly new, though, and if anything, have been easing. Calls for fiscal policy to complement monetary policy have also been part of the public discussion for some time, and already on November 28, Rehn devoted notably more time to urging that ‘fiscal policy should now remain neutral, not to increase inflationary pressures by boosting demand.’

We don’t think that Rehn’s reservations – either his ‘ceteris paribus’ or his much more explicit exhortation to ‘keep an open mind to adjust our policies if needed’ – reflect a gnawing suspicion on his part that the ECB’s hiking cycle will have to go beyond what the Governing Council had in mind at its last monetary policy meeting.

We lean in the opposite direction, suspecting that Rehn has become somewhat less sure that a further deceleration of the pace of tightening won’t actually be warranted already after February’s 50bp hike, notwithstanding ECB President Christine Lagarde’s promise last month that rates would now ‘rise significantly at a steady pace’.

As for Rehn’s invocation of Volcker and the drastic monetary policy tightening the latter needed to get inflation back under control in the US 40 years ago, the episode lends itself to such rhetorical use under the current circumstances. While Rehn went so far as to make it the title of his piece, the history lesson was mentioned recently by, for example, Banque de France Gouverneur François Villeroy de Galhau (March 12), Bundesbank President Joachim Nagel (May 10 and August 30), and ECB Executive Board member Isabel Schnabel (August 27).