By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Olli Rehn's speech on Tuesday mounted the clearest argument yet for characterizing a likely June rate hike as an “insurance hike,” even as it illustrated the peril of the phrase.

The idea of adjusting monetary policy to “insure” against developments is nothing new, but the run-up to next week’s meeting has seen a marked revival of the concept. The reason is straightforward: inflation risks are up significantly following the Iran conflict, but there is still only limited hard evidence that higher energy prices are feeding through into wages or broader price-setting behavior, even if some inflation expectations measures have moved higher.

Under those circumstances, it is only natural to see a modest rate increase as insurance against the risk that inflation pressures eventually become entrenched, and Rehn embraced precisely that logic.

"Against that backdrop, while inflation risks have increased, a rate increase in June would be an insurance one, but not due to entrenched inflationary pressures," he said.

Rehn's reasoning is difficult to dismiss; by the time inflation has unmistakably become entrenched, the opportunity for a modest preventive response may already have passed.

Yet this is where the term "insurance hike" becomes problematic.

Once policymakers describe a move as insurance, they risk creating the impression that one hike should be enough. After all, one does not normally take out two insurance policies against the same event.

Indeed, the relatively dovish Rehn himself lent that view support. Discussing a scenario in which inflation rises more significantly and remains above target for longer, but without convincing evidence of broad-based second-round effects, he said that rates could be increased as insurance to keep inflation expectations anchored.

"But it would not imply a start of a hiking cycle or lead to a more forceful monetary policy response," he said.

This goes to the heart of some Governing Council members’ uneasiness with the label.

An insurance hike is not necessarily a promise of "one and done." Such a promise would be incompatible with the ECB’s strictly data-driven, meeting-by-meeting, no-precommitment approach to policymaking — and with the extremely high uncertainty that makes confidence about future monetary policy unserious.

Yet it can easily sound like a promise. Whether explicitly or implicitly, once policymakers separate a rate increase from the beginning of a hiking cycle, they move dangerously close to offering guidance about what comes — or does not come — next.

This tension is visible elsewhere in the current debate. For example, in our interview last week with Governing Council member Gediminas Šimkus, he rejected the June insurance hike characterization.

"I do not think of this as an insurance hike," he said. "The nature of supply-side shocks is such that we have to weigh inflationary pressures that could become entrenched against the effect on an economy that is weak. At the moment, we still do not have much hard data on inflation."

At first glance, this sounds very different from Rehn's position. In reality, the gap is narrow.

Like Rehn, Šimkus believes policymakers are operating with limited information. Like Rehn, he sees the risk that inflation pressures could become entrenched. Like Rehn, he supports a June hike despite the absence of compelling evidence that such entrenchment has already occurred.

The difference is that Šimkus appears unwilling to attach a label that could be interpreted as an expectation that June will be all there is.

Rehn's speech offers a direct answer to that concern. The reason a June move can be described as insurance, he argues, is that inflation pressures are not yet entrenched. But, as he also made clear, that does not mean one hike has to suffice. Whether further action is needed depends on how the shock evolves and how households, firms and wage negotiators respond.

Rehn explicitly warned that the analysis could change if the conflict becomes prolonged and if the transmission from energy prices to wages and broader inflation proves stronger than currently observed. "It is therefore critical to monitor incoming data exceptionally closely," he said.

This is the subtlety at the heart of Rehn's argument.

A June hike would not represent the start of a hiking cycle under the ECB's current assessment of the situation. But neither would it rule one out; the same uncertainty that justifies an insurance hike also prevents policymakers from knowing whether one hike will ultimately prove sufficient.

That may be why the term continues to divide opinion within the Governing Council. It captures the logic behind a June move, but only imperfectly captures the uncertainty surrounding everything that might follow.

For ECB President Christine Lagarde, this is reason enough to avoid the phrase altogether next week. Rehn can devote a carefully reasoned speech to explaining what an insurance hike does and does not mean. A real-time press conference is a less forgiving venue.

Describing the Governing Council’s decision in conventional meeting-by-meeting, data-dependent terms would leave the same options available while avoiding a harmful debate over whether the ECB has implicitly promised that June will be enough.