Erosion of Fed independence would lead to higher inflation, ECB's Rehn says

• Trump's attacks on Fed could impact global markets, Rehn says
• Rehn says Europe's strong institutions likely to prevent similar problems
• Euro zone inflation linked to ECB's independent decision-making - Rehn

HELSINKI, Aug 28 (Reuters) - U.S. President Donald Trump's escalating attacks on the Federal Reserve could have substantial and global knock-on effects on the financial markets and the real economy, including higher inflation, ECB policymaker Olli Rehn said on Thursday.

Questions over the independence of the Fed, the world's most important monetary authority, have arisen this year as Trump repeatedly criticised its Chair Jerome Powell and on Monday announced he was firing one of its governors, Lisa Cook.

"If the central bank's independence were truly to crumble, and the U.S. Federal Reserve began making decisions on grounds other than sound monetary policy principles — for example, because the president demands lower interest rates — the inevitable consequence would be inflation picking up," Rehn said in a panel discussion on democracy held in Turku, Finland.

The Bank of Finland governor said Trump had exerted strong pressure on the Fed to cut interest rates for quite some time, despite its independence having been an inviolable principle since the beginning of the 1980s.

"Now, however, this principle is wobbling badly. This could have substantial, global knock-on effects on both the financial markets and the real economy," Rehn said.

He considered a similar development in Europe unlikely thanks to strong institutions, although he said the pressure could "spill over" across the Atlantic through certain countries and through the financial markets.

Europeans should take action to boost global confidence in the euro as a safe currency in order to avoid a similar deterioration of central bank autonomy in Europe, he said.

"It's no mere coincidence that euro area inflation is now at the 2% target — it is indeed connected to the central bank's independent decision-making," he said.

The dollar's global hegemony as a reserve currency has proven resilient, and therefore Rehn said he considered its rapid weakening unlikely.

"I say this, however, with one important caveat: if the dollar's institutional foundations were to crumble — I am referring to the principles of the rule of law and democracy, as well as civil liberties — we could find ourselves in a different situation."

While the euro zone's growth has proved more resilient than expected, Rehn said inflation was set to slow below the 2% target in the short term, due to cheaper energy, a stronger euro, and a slowdown in services inflation.

"In the ECB's Governing Council, we are closely monitoring the economic situation and stand ready to act if needed," Rehn said.