It’s action time for ECB with weak Euro a key point, Rehn Says

 The European Central Bank must act forcefully to contain record inflation and keep expectations for future price growth anchored as the weak euro exacerbates a surge in energy costs, according to Governing Council member Olli Rehn.

It’s important for policy makers to continue with a "consistent and orderly” normalization of monetary policy, Rehn, who heads the Finnish central bank, told Bloomberg Television at the Federal Reserve’s annual Jackson Hole gathering. His comments follow remarks by Executive Board member Isabel Schnabel and France’s Francois Villeroy de Galhau, who both highlighted the need for a determined response -- at the ECB’s upcoming meeting and beyond.

"The reality is that we have excessively high inflation globally, also in Europe -- that’s why it’s action time,” Rehn said. "The next step will be a significant move in September, depending on the incoming data and the inflation outlook.”

With consumer prices in the 19-nation euro zone rising at an annual rate of close to 10% -- an update is due on Wednesday -- some policy makers have started to discuss the merits of following the Federal Reserve’s playbook and raise borrowing costs by three quarters of a point. Others are more cautious, mindful of the economic headwinds that appear set to trigger a recession.

Money-market investors currently see an almost 50% chance of the ECB’s September rate increase exceeding half a point.
"Monetary policy is now facing the dual dilemma of on the one hand maintaining inflation expectations anchored, and on the other hand avoiding that we would push the economy into a recession,” Rehn said. "We have a severe energy crisis in Europe” and "it’s quite likely that the euro-zone economy is slowing down. It’s slowing down as we speak.”

The region needs to be prepared for a "protracted confrontation” with Russia, so reduced gas flows and higher prices for fossil fuels will be a "longstanding phenomenon,” Rehn said. "This will mean a serious cut in the purchasing power of our citizens.”

It also suggests there’s reason for concern that inflation expectations are becoming entrenched, he added. 
The recent slump in the euro is exacerbating the problem. The single currency has depreciated more than 12% against the dollar since the start of the year and is currently trading below parity. 

"Certainly we are monitoring the exchange rate,” Rehn said, reiterating the ECB’s standard line that it’s not a target but feeds through to inflation and is therefore taken seriously. 

"This indirect channel is important -- we are monitoring it and are looking at it as one indicator,” he said. "It’s already a significant consideration” in setting monetary policy.

With interest rates set to continue to rise, a debate is about to pick up about when the ECB should consider reducing its bond holdings after years of asset purchases -- a process commonly referred to as quantitative tightening. The Fed and the Bank of England have both started the process that allows longer-term bond yields to rise.

"It’s premature to start publicly talking about QT in the European context,” Rehn said. "We may each other think about that, but the time will be ripe later to discuss decisions concerning how to continue normalization of monetary policy as it regard asset purchases.”

A somewhat more urgent debate for the ECB is how to remunerate trillions of euros of excess reserves -- now that interest rates are no longer negative. Villeroy told the Jackson Hole audience that paying deposit rates would provide banks with "sizable risk-free income” that could jeopardize policy transmission while dealing a similar loss to the ECB and the region’s national central banks.

"That’s something that -- in my view -- we should discuss,” Rehn said. "We have some preparation discussions going on in this regard, but we will see to that in the forthcoming meetings -- in plural.”