ECB's Rehn Sees Phillips Curve Slowly ‘Waking From Its Coma’

(Bloomberg) -- The revival of a long-established relationship between unemployment and inflation is proceeding -- ever so slowly, according to European Central Bank Governing Council member Olli Rehn.

“We see some signs that the Phillips curve is waking from its coma,” said Rehn, referring to the theory first described by William Phillips in the 1950s. “It’s maybe alive but not kicking very much at the moment.”

ECB's Rehn Sees Phillips Curve Slowly ‘Waking From Its Coma’

According to the model, a workhorse of economics, declining joblessness in the euro area should have long ago sparked price pressures. Yet, discounting for the impact of oil and food prices, inflation has remained subdued even as wages started to pick up.

“The latest figures on core inflation were somewhat disappointing,” Rehn, who is also the governor of the Finnish central bank, said in an interview in Bali, Indonesia, on the sidelines of the annual meetings of the International Monetary Fund and the World Bank. “We’ll have to watch very carefully how underlying inflation materializes from now on.”

What our economists say:
“Core inflation slowed to 0.9% from 1%. The figure remains below the highs of the last couple of years, but along with the other underlying measures, it should gradually firm as the economy operates only slightly below its trend.”

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The ECB is confident price growth is only temporarily delayed and announced it will cap bond purchases at 2.6 trillion euros ($3 trillion) at the end of the year. It pledged interest rates would remain on hold at least “through the summer” of 2019, leaving room for some flexibility that investors currently interpret as no earlier than September next year.

“‘Through the summer’ is very clear,” Rehn said. “There’s no disagreement on that.”

Governing Council member Francois Villeroy de Galhau said in a Sunday speech in Bali that there’s no rush to clarify the ECB’s guidance. His colleague Klaas Knot said policy makers might contemplate bringing forward the rate liftoff if the economy develops as strongly as currently projected.

ECB's Rehn Sees Phillips Curve Slowly ‘Waking From Its Coma’

After the first rate increase, the ECB should gradually move away from hinting at the timings of future moves and link policy steps to incoming economic data, Rehn said.

Reinvestment Policy

Before that, policy makers will have to decide how to roll over maturing bonds acquired under quantitative easing. While details of the reinvestment policy still need to be decided, the Finnish governor said the ECB should uphold its strategy of dividing purchases among national central banks proportionally to the size of their economies and population. The so-called ‘capital key,’ last revised in 2014, is due for review in 2019.

“The new capital key is going to be the guiding principle,” Rehn said. “To my mind, it is inbuilt in the treaty-based nature of the ECB and the Eurosystem that we respect the capital key.”

ECB's Rehn Sees Phillips Curve Slowly ‘Waking From Its Coma’

In the interview, Rehn also reiterated that Italy’s populist government shouldn’t expect the ECB to alter its policy course to accommodate its demands or to shield it from investor speculation. Concern over the future course of the euro area’s third largest economy has been one of the recurring themes of the world’s financial elite in Indonesia.

“The ECB and the Governing Council don’t take decisions on monetary policy based on the economic situation, and even less the political situation, in any member state, even if systemically important,” he said. “The Governing Council focuses particularly on the price-stability target in the medium term and, as long it is being achieved, on the other goals of European Union economic policy, which are sustainable growth and job creation.”

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