ECB's Rehn warns energy and AI risks cloud rate path

ECB Governing Council member Olli Rehn has pointed to growing policy challenges for the central bank in his remarks today. He stated that:

• Rising energy costs are pushing inflation closer to the ECB's adverse scenario
• ECB forecasts face extremely high and widespread uncertainty
• Higher long-term interest rates will curb growth and limit how much of the energy shock is passed through to prices and wages
• A sudden shift in market sentiment regarding artificial intelligence is a source of uncertainty

The ECB's baseline projections from September put average inflation at 3.0% this year and 2.5% in 2027. Under the adverse scenario, inflation is forecast to rise to 3.2% next year instead.

Rehn's comments therefore focus on linking higher energy prices to that scenario and what it might mean for the ECB's policy response.

He argues that rising long-term rates will weigh on economic expansion and thereby reduce how much firms can pass on energy costs to consumers. This leaves the ECB caught between inflationary pressure from energy and tighter financial conditions that effectively do some of the monetary tightening for it.

His warning on AI adds to that uncertainty, as a sharp reversal in technology valuations could tighten financial conditions further.

For financial markets, this helps explain why the next move is not seen as certain.

Last month, traders were more convinced the ECB would need to raise rates again before the end of the year, with a 25-basis-point hike priced in for December. Now, market pricing shows a roughly 27% chance of an October rate increase, while a December hike is seen at about 64%.

As a reminder, the ECB continues to follow a meeting-by-meeting approach rather than committing to a predetermined path after the September rate hike. Waiting until December may give the ECB something October cannot: more time to see if the energy shock is feeding into broader prices and wages.