Introductory statement with Q&A
Jean-Claude Trichet, President of the ECB,
Lucas Papademos, Vice President of the ECB,
Frankfurt am Main, 3 August 2006
Ladies and gentlemen, the Vice-President and I are very pleased to welcome you to this press conference to report on the outcome of today’s meeting of the Governing Council. The meeting was also attended by Commissioner Almunia.
At today’s meeting, we decided to increase the key ECB interest rates by 25 basis points. This decision reflects the upside risks to price stability over the medium term that we have identified through both our economic and monetary analyses. It will contribute to ensuring that medium to longer-term inflation expectations in the euro area remain solidly anchored at levels consistent with price stability. As stressed on previous occasions, such anchoring is a prerequisite for monetary policy to make an ongoing contribution towards supporting economic growth and job creation in the euro area. Also after today’s increase, the key ECB interest rates remain low in both real and nominal terms, money and credit growth remain strong, and liquidity in the euro area is ample by all plausible measures. Our monetary policy therefore continues to be accommodative. If our assumptions and baseline scenario are confirmed, a progressive withdrawal of monetary accommodation will be warranted. Against this background, we will continue to monitor very closely all developments so as to ensure price stability over the medium and longer term.
Allow me to explain our assessment in greater detail, starting with the economic analysis.
The main indicators of economic activity that have become available since the July press conference have tended to confirm our baseline scenario for economic growth in the euro area. Eurostat’s second release verified that, in the first quarter of 2006, real GDP grew by 0.6% on a quarter-on-quarter basis. Economic activity is also becoming more broadly based on domestic demand. Moreover, the currently available information on economic activity in the second quarter – such as various confidence surveys and monthly indicators – supports the view that economic growth has continued at a sustained pace. The survey information so far available for the third quarter is also in line with our baseline scenario.
Looking further ahead, the conditions are in place for real GDP in the euro area to grow at around its potential rate, as projected by Eurosystem staff in June. Growth in the economies of the euro area’s main trading partners is providing ongoing support for euro area exports. Investment growth is expected to continue benefiting from favourable financing conditions, corporate balance sheet restructuring, and improvements in earnings and business efficiency. Consumption growth should continue to strengthen gradually over time, in line with developments in employment growth and hence real disposable income. This generally favourable outlook for economic activity in the euro area is also reflected in forecasts by international organisations and private sector institutions.
Risks to the outlook for economic growth are broadly balanced over the shorter term, although recent geopolitical tensions and their impact on markets are a timely reminder of the uncertainties that we face. Medium to longer-term risks lie on the downside and relate in particular to the potential for further oil price rises, a disorderly unwinding of global imbalances and protectionist pressures, especially after the suspension of the Doha Round of trade talks.
Turning to price developments, according to Eurostat’s flash estimate, annual HICP inflation was 2.5% in July 2006, unchanged from June and May. In the second half of 2006 and on average in 2007, inflation rates are likely to remain above 2%, the precise levels depending very much on future energy price developments. While the moderate evolution of labour costs in the euro area is expected to continue in 2007 – also reflecting ongoing global competitive pressures, particularly in the manufacturing sector – indirect effects of past oil price increases and already announced changes in indirect taxes are expected to exert a significant upward effect on inflation in the course of next year. Against this background, it is crucial that the social partners continue to meet their responsibilities.
Risks to the outlook for price developments have augmented and include further increases in oil prices, a stronger pass-through of past oil price rises into consumer prices than currently anticipated, additional increases in administered prices and indirect taxes, and – more fundamentally – stronger than expected wage and price developments owing to second-round effects of past oil price increases at a time of gradually improving labour markets.
Regarding prospects for inflation over medium to longer horizons, our assessment that upside risks to price stability prevail is confirmed by the monetary analysis. While the data for June 2006 show some moderation in the annual growth rate of M3, these latest developments remain consistent with a persistent upward trend in the underlying rate of monetary expansion since mid-2004. The stimulative impact of the low level of interest rates in the euro area has been an important factor behind the tendency for money and credit growth to strengthen over recent quarters.
Looking at the counterparts of M3, the expansion of credit to the private sector remains the main driver of monetary dynamics. On an annual basis, loans to the private sector as a whole have continued to increase at double-digit rates over recent months, with borrowing both by households and by non-financial corporations rising rapidly. Ongoing strong lending to households continues to be explained, in particular, by borrowing for house purchases. The dynamic growth of money and credit, in an environment of already ample liquidity, points to increased upside risks to price stability at medium to longer horizons. Monetary developments therefore require careful monitoring, particularly in the light of strong dynamics in housing markets.
To sum up, annual inflation rates are expected to remain elevated, at above 2% on average, in 2006 and 2007, with risks to this outlook on the upside. Given strong monetary and credit growth in a context of ample liquidity, a cross-check of the outcome of the economic analysis with that of the monetary analysis confirms that upside risks to price stability prevail over the medium term. A further adjustment of interest rates was therefore warranted. By acting today in a timely fashion, the Governing Council is helping to anchor medium and long-term inflation expectations at levels consistent with price stability, thereby making an ongoing contribution to sustainable economic growth and job creation. Looking ahead, given that our monetary policy continues to be accommodative, a progressive withdrawal of monetary accommodation will be warranted if our assumptions and baseline scenario are confirmed. The Governing Council will continue to monitor very closely all developments so as to ensure that risks to price stability do not materialise.
Concerning fiscal policies, given the outlook for economic growth, it is of crucial importance that euro area governments avoid pro-cyclical policies and step up the pace of fiscal consolidation. As budgetary targets for the current year are not particularly ambitious, a rigorous implementation of plans on the expenditure side is especially warranted, and any additional windfall revenues are best used for deficit reduction. Beyond the implementation of such prudent policies in the remainder of this year, the medium-term focus of fiscal policies should be on correcting the underlying sources of imbalances in public finances. Euro area governments, many of which are now finalising their budget plans for 2007, should take full advantage of the economic environment to bring forward the structural adjustment necessary for the durable correction of excessive deficits, so as to reach their medium-term budgetary objectives at an early stage and thereby prepare public finances for the acute demographic challenges they must cope with.
As regards structural reforms, it is essential, for Europe’s future, to ensure that it has a fully operational Internal Market, allowing a free flow of labour and capital and free trade in goods and services. Removing the remaining barriers within the EU will be a powerful means to promote the efficient allocation of factors of production as well as deeper economic and financial integration. This in turn would allow the EU to realise its substantial potential for stronger output and employment growth and to increase its resilience to shocks. Exploiting the opportunities of the Single Market will help to safeguard the prosperity of the citizens of Europe. For those Member States which have fulfilled the convergence criteria laid down by the Treaty and participate in the euro area, the considerable benefits of the Internal Market are further enhanced by the single currency, which offers them a credible framework for monetary policy and price stability in an environment characterised by the absence of exchange rate uncertainty within the euro area, low long-term interest rates, price and cost transparency, reduced transaction and information costs and stronger insurance against economic and financial instability.
In this respect, the further enlargement of the euro area on 1 January 2007 with the entry of Slovenia will be a new historical landmark. In order to fully reap the advantages of the euro and to allow adjustment mechanisms to operate efficiently within the enlarged currency area, it will be necessary to fully integrate Slovenia into Economic and Monetary Union, which calls for all remaining barriers to be removed, including those related to labour mobility. Indeed, open, competitive and flexible markets are of particular importance for the functioning of the euro area economy and the smooth conduct of the single monetary policy. For its part, the Governing Council has undertaken all the necessary preparations to make Banka Slovenije an integral part of the Eurosystem.
We are now at your disposal for questions.
Transcript of the questions asked and the answers given by Jean-Claude Trichet, President of the ECB, and Lucas Papademos, Vice-President of the ECB
Question: Did you discuss the pace and timing of future rate hikes and, in that regard, I noticed that you say that you will be monitoring very closely the conditions moving forward. Previously, when you have used that phraseology, you have proceeded with an interest rate increase two meetings later. So, if in case your baseline scenario is confirmed, would it be a reasonable assumption to be looking toward October?
Trichet: I stick to what I said in my introductory statement. As you heard, it is our sentiment that if our baseline scenario is confirmed, we will progressively withdraw the present monetary accommodation. That is clearly the way we are looking at the situation and also the way that observers are looking at the situation. I do not want to say anything else, but we will continue to monitor the situation very closely. I will not comment on your own hypothesis.
Question: I would like to try you again on that question: what was the flavour of the discussion in the Council today, are we more likely to see a step in two months or three months? My second question is: the Bank of England today raised interest rates somewhat unexpectedly. Do you think that markets and observers are in any way underestimating the threat inflation poses at the moment? And the extent to which central banks will raise rates to counter that?
Trichet: I will not comment on the decision of the Bank of England, which happened to be on exactly the same day. As regards our own decision, it was not unexpected. And as regards the way we look at the future, it has been absolutely clear since the very beginning of our first move in December last year that we do not decide ex-ante future decisions over the medium run. I said that we were not pre-committed to any two months, three months or any kind of rhythm. I have always myself said that we depend on the confirmation of our baseline scenario, on facts and figures. We will see what will be the judgement of the Governing Council when the time comes. Again we are not pre-committed in any respect. We will do all what we judge appropriate, depending again on the wealth of information that we have, coming from our own analysis and the very impressive wealth of information and analysis from public and private institutions. As regards the position of central banks in general, as far as you refer not only to us, but to the community of central banks, I would say that we all consider that being credible in our mandate to deliver price stability not only on a short-term basis, but on the medium and long-term basis, and therefore, solidly anchoring inflationary expectations, is of the essence. It is the trust of all central banks I know, and certainly of those with which I am in permanent contact. It is of course, as you know well, our very strong belief. We have a mandate, we are faithful to our mandate and we believe that it is the best way to help growth to be sustainable and job creation which, very fortunately, is now visible, sustainable in the medium and long run.
Question: If you compare the situation now to what we have observed at the last meeting, we had some encouraging data but we also had the conflict in the Middle East. Would you – looking at the risks to price stability and growth – think the risks have increased or decreased for growth in recent weeks? And the same please for price stability?
Trichet: As I said, we depend permanently on new information. I also mentioned the fact that we live in a world where uncertainty, and indeed great uncertainty, is unavoidable. This is particularly the case as regards the geopolitical risks that I mentioned. I would say that on a short to medium-term basis, the risks to growth are in our opinion balanced. On a longer-term horizon, we see a number of downward risks. That is the best summing-up of our present view. On the particular impact of geopolitical risks, I do not see, at this very moment that these have contributed in any significant fashion to hampering growth. But it is clearly a risk that has to be taken into consideration. Fortunately, I have not seen, and I hope strongly not to see, an impact of these events on global growth.
Question: Three brief questions. After the last policy meeting, a lot of the ECB watchers shared the view that the Council would prefer to move gradually on interest rates, unless it was unavoidable. And to do so more frequently, if needed, than over a sharp interest rate move. Would you say that is a fair appraisal of the Governing Council’s sentiment? And the second question is: do you believe that concerns about financial stability or financial imbalances in the euro area have increased since the early months of this year? And, finally, you mentioned just now the moderation in M3 growth. I would just like to ask if you feel that is a sign in your view that policy changes are starting to take effect in the euro area?
Trichet: On your first question, I already said, that we are not pre-committed in any respect. We do what we judge to be appropriate and necessary, and I think that the market has understood that pretty well. There is no particular rhythm of three or two months. We are not pre-committed as regards the frequency of our progressive withdrawal of monetary accommodation, if facts and figures confirm our baseline scenario. And we will continue to behave in this fashion.
I will not comment on financial stability. I do not see any element that would be significant at this stage.
On M3, as I said, we have observed a certain signal which, of course, is difficult to interpret at this time. The decisions we took since December as well as the fact that the market is anticipating our decisions, and that the yield curve is showing an upward trend, all this has played a role. Is it a sufficiently significant influence to trigger what we are observing now and mark the beginning of a deceleration? We will see. Of course, I prefer what we have observed in the latest statistics to the previous evolution. Note the figures are still very impressive. When you look at the figures we have, particularly as regards loans to the private sector, loans to non-financial corporations – which are increasing at a pace of 11.5% in June, compared with 11.3% in May – we still have very strong dynamics. And the pace continues to increase as regards that particular segment of loans, even if loans to the private sector in general decreased slightly to 11% in June from 11.4% in May. But again it is something that we will continue to look at very carefully. Look at the components of M3. Look at its counterparts. And you will better understand all the dynamics that are at stake. Again I will not, at this stage, say “we now clearly see the first signs that what we have been doing in increasing our interest rates is working”. But our policy changes are, of course, playing a role because the interest rates applied by the banks that are granting those loans are rising.
Question: I have two brief questions. First, I wonder if you can tell us whether the decision today was unanimous? And, secondly, you have just stressed the Bank’s mandate of price stability. But projections, including the Eurosystem’s own, forecast that growth will slow down in 2007. So I wonder whether you can tell us whether there has been a discussion of a situation in which you have simultaneously rising inflation pressures and slowing growth, and what that discussion was like?
Trichet: First of all, the decision in favour of a 25 basis point increase today was overwhelmingly supported by the Governing Council.
As regards our assessment of the risks to price stability and to growth I have told you clearly that we saw the risks to price stability over the short, medium and long term to be on the upside. We consider the risks for growth to be balanced, on a short to medium-term basis, and to be on the downside over the longer term. That is our present analysis. That being said our mandate is clear. We have to deliver price stability. It is not only the mandate given to us by the Treaty but also our responsibility vis-à-vis the households of Europe and the fellow citizens of Europe, who expect us to deliver price stability. It is also the working assumption of the social partners. And this is the reason why we tell them: be responsible yourself, because we will take care of price stability. It is also essential because it is through our credibility that we anchor inflationary expectations. As I said in my introductory statement in the euro area we have long-term rates that are favourable to sustainable growth and sustainable job creation, in particular, because we are solidly anchoring inflationary expectations. We see no contradiction between our mandate and sustainable growth and sustainable job creation.
Question: Could you give us the flavour of your thinking regarding the pass-through of past oil price rises and commodity price rises in general through the price chain, whatever you want to call it. There has been some evidence in the surveys that this is creeping closer to the consumer, but perhaps this is not quite there yet. My second question is on the fiscal side of things. I wonder if you could just elaborate a little bit on your point of needing change on the expenditure side. My understanding of the fiscal structures of the Stability Pact was always that this was one area where governments preserved, and indeed deserved, their leeway as to how they chose to balance their budgets. It surprises me somewhat that you appear to be telling euro area governments that they should not raise taxes, that they should cut spending. And my third question is just a very small factual one. I realise that Slovenia is a very small new member of the euro area. But does this have any sort of one-off effect on the statistics or what one observes on the economic activity in the euro area as a whole, since its composition is changing, however slightly.
Trichet: On the first point, I mentioned the risks that we saw to prices and I mentioned a number of those risks – such as the increase in the price of oil – which we have observed in the past, unfortunately, I have to say, and which are still a risk. I mentioned additional increases in prices – I am not mentioning past increases that have already been decided and fully incorporated in our own projections, but rather the possible future increases in administrative prices and indirect taxes – and I mentioned the traditional – in this press conference – second-round effects, in particular wages and salaries increases. There is also the point which you have mentioned, which we consider ourselves to be very important and which has to be examined very carefully, namely what we call a stronger than currently anticipated pass-through of past oil prices and I could add of past commodity prices. There are increases in input prices that do not materialise immediately in increases in output prices, in manufacturing goods or in the services prices concerned, but this process is going on, on a continuing basis and that is something which has to be followed very carefully. That would be my comment on your first question. Just because you don’t see an immediate effect, an immediate mechanistic effect of these increases in oil and commodities prices, that does not mean that you do not have in the pipeline costs that would push prices up later on. This is difference from the second-round effects.
On the fiscal side, I would only say that we have always told our interlocutors, the Commission and the executive branches, that in delivering the appropriate fiscal position required by the Stability and Growth Pact, in an overwhelming majority of cases, to be as sound and reasonable as possible on the expenditure side is the first best option. Then, if something remains to be done, in order to meet this Stability and Growth Pact requirement, you have to do what remains necessary on the receipt side, namely taxation. But the first best option is always to have a sound handling of the expenditure side. There is nothing new there; we have always said that. And I have to say that it is particularly true in the euro area, where the level of public expenditure – public spending as a proportion of GDP – is quite significantly higher than the OECD average or the G7 average. So we have to be fully conscious of that structural difference.
As regards Slovenia, of course we are very happy to be enlarging the euro area and we will have a fully fledged set of statistics that will permit a full comparison of what happens from 1 January next year with what has happened before. So, you will have all possibilities to compare statistics of the highest quality on a state of the art professional basis. But allow me to stress that we an important message in relation with Slovenia. Perhaps you have noticed that we said that we will be, when next year starts, in a euro area with 13 economies instead of 12 sharing a common destiny with a single currency. We consider that it would be very opportune for labour mobility between Slovenia and the European Union and in particular with all the members of the euro area, to be totally free without barrier within a single market area with a single currency, full labour mobility is absolutely necessary.
Question: Mr Trichet, I have two questions. You said that there was an overwhelming majority in favour of the decision you made today in the Governing Council. I take from that word that there were perhaps two or three members who might have preferred, at least at the start of the discussion, another decision. What did they want? Did these members not want to move at all with a rate hike today or did they prefer to have a larger hike?
Trichet: Let me be more precise. By “overwhelming majority” I meant a fully-fledged consensus. There were no other views on today’s decision.
Question: The second question I have relates to the economic outlook in the short and medium term and then the medium to longer term. There are a lot of economists seeing that there might be some kind of cooling down in the euro area economy. Do you have a discussion in the Governing Council – assuming that you want to normalise interest rates, whatever you regard as a normal level – do you have a discussion in the Council that the time is running out for interest rate hikes?
Trichet: First of all, the “normal level” for us is the level which permits us to deliver price stability over time, be credible in the delivery of price stability over time and solidly anchor inflationary expectations. There is our compass and the needle of the compass. Second, as I have said very often, we are pragmatic. Everybody knows what our definition of price stability is. Everybody knows what our determination is. Everybody knows what our two-pillar monetary policy strategy is. Now, we will do what is necessary, depending on facts and figures and new events. At this stage, I will not comment further. Of course, we will have new projections, as you might expect. We have our present projections. We have our baseline scenario and we might have a lot of new events – price of oil, geopolitical uncertainty, also good surprises that we might have in the rest of the world. We could also be – I do not exclude that at all – surprised by the dynamism of the domestic economy of the euro area. We have a number – as you know very well, better than anybody – of survey indicators that are very impressive and that are still not materialising fully – particularly in the services sector, where the survey indicators are much better than the present so-called hard figures. I do not believe that hard figures are the only reliable figures or that survey figures are the only reliable figures. We have to make the best out of this wealth of information, but it is clear that there are areas where we could have good surprises. Again, even if I said that our own sentiment for growth was balanced on a short-term basis, it means that we have downside risks on the one hand, but we have also upside chances on the other hand. And we have to take that into consideration also. That being said, you can count on us to do what we judge necessary. If our baseline scenario is confirmed, if our assumptions are confirmed, then we will progressively withdraw monetary accommodation.
Question: Mr President, you mentioned that the euro area will grow around a potential rate? Can you define “potential rate”? The potential rate was, in former days, at the beginning of the euro area eight years ago, approximately 2½ %. Some economists said that it is lower now. What is necessary to increase this rate? And what is the defined “potential rate” you have mentioned without giving a figure? Because the potential rate was, in former days, a very important number for anchoring price stability; I remember the “M3 reference value”.
Trichet: You know that there are a number of analyses which do not converge in the direction of an overall consensus on our growth potential. And you have also to distinguish the short-term growth potential, and the medium and long-term growth potential. Let me first address the very important issue of labour productivity increases. I would like to take advantage of your question, which is extraordinarily important, to mention the fact that our main handicap in terms of growth potential remains the fact that productivity growth is much too small in the euro area. During the last five years, say, we have been at a level which is half the level observed in the United States in terms of the yearly increase of labour productivity and which is also half the level observed in the economies of the euro area in the eighties. If we were at the level that we had in the eighties, or if we were at the level which is presently posted by the United States, we would have a growth potential which would be significantly higher. This is the reason why we are calling for structural reforms, because we firmly believe that it is the lack of structural reforms particularly in a period of very rapid changes in science, technology, and globalisation, that explains why we have a disappointing level of increase of labour productivity. That being said, you asked for figures. We will not underwrite any figures ourselves. But I can mention a number of studies which suggest that, for the euro area as a whole, we could be at the level of 1.9%. Others suggest that we are in-between 2% and 2.5%, but possibly much closer to 2% than to 2.5%. You have a number of such analyses. And again, I will not underwrite any figures, but I would say that if you said in the present situation that perhaps 2% might be an order of magnitude it would not necessarily be absurd. But, again, one has to accept there are various methodologies, various views – short-term and more medium and long-term. In any case, our growth potential should be much higher. It is not a parameter which is fixed and immobile. It depends on what we do. And it can be much higher.
Question: Do you remember your dinner speech on 31 March at the IIF meeting in Zurich? There you mentioned a figure: was it 1.8 or 1.9?
Trichet: My memory is that I mentioned a figure of around 1.9.
Question: You referred to the survey data that has been relatively good. However, some of it has started to soften a little bit, to come off the peaks. Has the business cycle in the euro zone peaked? And secondly, on budget consolidation, we have numbers from Germany and some numbers from Italy, and economists are starting to estimate what impact this will have on growth in 2007. The estimates range between 0.5 and 1.3 – those that I have seen – in terms of reducing GDP growth next year. What is your estimate of what impact fiscal consolidation could have next year?
Trichet: Taking the second question first. You know that we consider that fiscal consolidation – at the present level of the risks and dangers that exist in the various economies of the euro area today – is improving the confidence of entrepreneurs, the confidence of economic agents in general and the confidence of households. All the mechanistic computations that would go through mechanistic models are not necessarily reliable, because they do not take into account what I would call the Ricardian channel. Never forget that, when you are credible in a medium-term path of fiscal consolidation, you are improving confidence. And confidence is one of the ingredients that is decisive to foster growth: fortunately, we are in an episode of improving confidence in Europe.
On your first question, I would say that we are totally pragmatic: we will see what happens. I have no judgement on whether some survey indicators have peaked or not. I have mentioned that, particularly in the domain of services, we still see a large gap between the level of survey indicators, which is very flattering and very encouraging, and the level of the so-called hard figures. My intuition is that the hard figures themselves will go up. But we will see what happens, and again, we have to be cautious. Reality is reality, facts are facts, and we have to be humble in front of facts. Therefore I have no comment on whether some survey indicators have peaked or not. But, as you know, some of them are at historical levels which are very flattering.
Question: You said in today’s statement that rates are still accommodative and that the further withdrawal of accommodation will be warranted if your main scenario continues to be confirmed. The markets are debating whether rates will reach 3.25% or 3.5% by the end of the year. It sounds from today’s comments very much like you still see some room to move; it does not sound like there is an imminent end to your tightening cycle. I wonder if you could give us your opinion on whether you see that there is some way to go before rates are no longer accommodative.
Trichet: Again, I have said all I have to say on that. I can only confirm to you that, if our scenario and our assumptions are confirmed, there will be a progressive alleviation of the monetary accommodation that exists today. I have said that for quite a period of time, and you can see what we have been doing.
Let me also mention something which has been discussed in the Governing Council, namely the Doha round. You did not ask many questions on this issue but it is very important for us. We have always said that a positive conclusion of this round was of the essence. The fact that we are in a difficult episode is something that we follow very carefully. We consider that it is one of the risks that I have constantly mentioned. I would call on all governments concerned to be fully aware of what is at stake in this round of negotiations and to make their best efforts to cope with the current difficulties and to find a solution.