By David Barwick – WASHINGTON (Econostream) – European Central Bank Governing Council member Olli Rehn on Thursday said the ECB would need to tighten monetary policy “decisively and forcefully” if the war in Iran became protracted, generated second-round effects on prices and wages and threatened to disanchor inflation expectations.

Speaking at a conference of the Reinventing Bretton Woods Committee, Rehn, who heads the Bank of Finland, said the conflict was already a negative terms-of-trade shock for Europe, with the “short-term impact” clear in that “[i]nflation will increase this year, while growth will weaken,” even if “the medium-term effects are still uncertain.”

That uncertainty made the ECB’s medium-term orientation especially important, he said. “[W]hat matters most is not the immediate increase in prices, but whether the shock has persistent effects on inflation and the general price level,” he said. “Right now, the outlook is foggy.”

“In these times of pervasive uncertainty, monetary policy must be conducted with a steady hand, depending above all on the duration of the conflict and the damage it inflicts,” he said, laying out two main alternatives for policymakers.

Should the damage on energy markets remain limited in time and scale, “it could be possible though by no means certain that the rise in energy prices could be ‘looked through’ in monetary policy,” he said.

A more severe outcome would require a different response, he said. “If this were to generate second-round effects on prices and wages and if inflation expectations were to become unanchored, monetary policy would need to be tightened in line with our strategy — decisively and forcefully.”

Even so, Rehn signaled no readiness to prejudge the next move. “Calm judgment will prevail over haste, and no decisions are predetermined,” he said, adding that the Governing Council remained committed to keeping inflation “stabilized sustainably around our 2% target over the medium term.”

He also warned against treating past energy shocks as straightforward templates for the current one. “Every shock is different,” he said. “Crises are not twin sisters.”

Looking back at earlier episodes, Rehn recalled that the ECB had brought inflation back to target after the 2022 energy shock without causing a recession or mass unemployment, while noting that the two rate hikes delivered in spring 2011 were later reversed that same year.

Pass-through from energy to broader inflation depends on more than the oil price move itself, he argued. “The effect on inflation depends on the state of the economy,” he said. “That’s why we closely monitor second-round effects and inflation expectations.”

Beyond the immediate monetary-policy challenge, Rehn said the war had underscored Europe’s structural dependence on imported fossil fuels. “The Iran war underlines that the green energy transition is essential for Europe’s strategic autonomy and competitiveness — and for the climate,” he said. “Slowing the green transition now would be a serious mistake.”