Introductory statement with Q&A

Jean-Claude Trichet, President of the ECB,
Lucas Papademos, Vice President of the ECB,
Frankfurt am Main, 2 November 2006

Jump to the transcript of the questions and answers

Ladies and gentlemen, let me welcome you to our press conference and report on the outcome of today’s meeting of the ECB’s Governing Council. The meeting was also attended by Mr Heinäluoma, President of the Ecofin Council, and Commissioner Almunia.

On the basis of our regular economic and monetary analyses, we decided at today’s meeting to leave the key ECB interest rates unchanged. The information that has become available since our last meeting has further underpinned the reasoning behind our decision to increase interest rates in October. It has also confirmed that strong vigilance remains of the essence so as to ensure that medium to longer-term inflation expectations in the euro area remain solidly anchored at levels consistent with price stability. With the key ECB interest rates at still low levels, money and credit growth dynamic, and liquidity ample by all plausible measures, our monetary policy continues to be accommodative. If our assumptions and baseline scenario continue to be confirmed, it will remain warranted to further withdraw monetary accommodation. Indeed, acting in a firm and timely manner remains essential to ensuring price stability over the medium term. As emphasised on previous occasions, this is a prerequisite for monetary policy to make an ongoing contribution towards supporting sustainable economic growth and job creation in the euro area.

Allow me to explain our assessment in greater detail, turning first to the economic analysis.

Eurostat’s second estimate confirmed that real GDP growth in the euro area was 0.9% quarter on quarter in the second quarter of 2006, after 0.8% in the first quarter. Looking through the usual volatility of quarterly growth rates, economic activity has been growing at an average quarter-on-quarter rate of 0.7% over the four quarters to mid-2006, and thus faster than generally expected a year ago. On the basis of various monthly indicators of economic activity and confidence surveys, available up to October, the momentum of the economic expansion is expected to have continued in the second half of this year. In addition, the unemployment rate has been declining, employment growth has recovered and employment expectations remain favourable. All in all, the assessment of a more broadly based and more self-sustaining recovery continues to be confirmed by the incoming data, notwithstanding some possibility of a somewhat slower pace of quarter-on-quarter real GDP growth in the second half of this year than in the first.

Looking further ahead, the conditions remain in place for the euro area economy to grow at solid rates around potential, although some volatility in the quarterly growth rates is likely to emerge around the turn of the year, mainly reflecting the impact of an increase in indirect taxes in a large euro area country in January 2007. Global economic activity has become more balanced across regions and remains robust, thereby providing ongoing support for euro area exports. Investment is expected to remain dynamic, benefiting from an extended period of very favourable financing conditions, balance sheet restructuring, accumulated and ongoing strong earnings, and gains in business efficiency. Consumption growth in the euro area should also strengthen further over time, in line with developments in real disposable income, as employment conditions continue to improve.

Risks to the outlook for economic growth are broadly balanced over the shorter term, taking into account, in particular, the recent slowing down in the US economy on the one hand and the recent fall in oil prices on the other. The oil price decline – if it were to prove lasting – has the potential to lead to somewhat stronger demand and output growth than embodied in our current baseline scenario for activity in the coming quarters. Over the longer term, risks to growth continue to lie on the downside, relating mainly to the possibility of a renewed increase in oil prices, fears of a rise in protectionist pressures, especially after the suspension of the Doha round of trade talks, and possible disorderly developments owing to global imbalances.

As regards price developments, according to Eurostat’s flash estimate annual HICP inflation was 1.6% in October, after having declined to 1.7% in September from 2.3% in August. The recent decline in inflation is the combined result of favourable base effects, given in particular the strong rise in oil prices a year ago, and the recent significant fall in oil prices. While the outlook for energy prices remains uncertain, on the basis of current energy prices and the higher quotations on futures markets, inflation rates are likely to increase again in the next few months and early 2007. As a consequence, we expect a high degree of short-term volatility in the annual HICP inflation rate. Looking through this volatility, however, HICP inflation will remain elevated at a level above 2% on average in 2006 and is likely to remain so in 2007.

Risks to the outlook for price stability remain clearly on the upside. They continue to include a stronger pass-through of past oil price rises into consumer prices than currently anticipated and additional increases in administered prices and indirect taxes beyond those announced thus far. Furthermore, renewed increases in oil prices cannot be excluded. More fundamentally, given the favourable momentum of real GDP growth observed over the past few quarters and the ongoing improvement in labour markets, stronger than currently expected wage developments pose substantial upward risks to price stability. Against this background, it is crucial that the social partners continue to meet their responsibilities, particularly in the context of a more favourable environment for economic activity and employment.

The monetary analysis continues to point to upside risks to price stability at medium to longer horizons. Annual M3 growth rose again to 8.5% in September, after having increased to 8.2% in August. Although the annual growth rate of M1 has moderated somewhat in recent months, reflecting shifts into instruments with more market-related returns in a context of rising interest rates, this has been more than compensated by the stronger expansion of the other components of M3.

More generally, the rate of monetary and credit expansion remains rapid, reflecting the still low level of interest rates in the euro area and the strengthening of economic activity. In particular, loans to the private sector continue to grow at double-digit rates on an annual basis, their dynamism remaining broadly based across the household and corporate sectors. While the growth of household borrowing shows some signs of stabilisation, albeit at very high rates, the growth of borrowing by non-financial corporations continues to trend upwards and has now reached rates of over 12% on an annual basis, the highest seen since the early 1990s. Thus, when the counterparts of M3 are considered, the main driver of strong monetary growth remains the expansion of credit to the private sector.

Taking the appropriate medium-term perspective, the latest developments are consistent with a continuation of the persistent upward trend in the underlying rate of monetary expansion, identified by the ECB’s monetary analysis since mid-2004. Furthermore, following several years of robust monetary growth, the liquidity situation in the euro area is ample by all plausible measures. Continued strong monetary and credit growth in an environment of ample liquidity point to upside risks to price stability over the medium to longer term. Monetary developments therefore continue to require very careful monitoring, particularly against the background of improved economic conditions and strong property market developments in many parts of the euro area.

To sum up, annual inflation rates are projected to remain elevated in 2006 and 2007, with risks to this outlook remaining clearly on the upside. Given the ongoing marked dynamism of monetary growth in an environment of ample liquidity, a cross-check of the outcome of the economic analysis with that of the monetary analysis supports the assessment that upside risks to price stability prevail over the medium to longer term. It is essential that inflation expectations remain firmly anchored at levels consistent with price stability. If our assumptions and baseline scenario continue to be confirmed, it will remain warranted to further withdraw monetary accommodation. Indeed, acting in a firm and timely manner remains essential to ensuring price stability over the medium term. The Governing Council will therefore exercise strong vigilance.

As regards fiscal policy, euro area countries have recently notified their deficit and debt figures for 2005 to the European Commission, and most have reported on developments in 2006 and budget plans for 2007. While, on average, this information points to further, albeit slow improvements in budget balances, this should not give rise to complacency. It is important that commitments under the revised Stability and Growth Pact are met in all euro area countries. It is essential that budgetary consolidation is strengthened in the current economic upswing and that pro-cyclical policies are avoided. This would boost confidence among market participants and the public. To that effect any revenue windfalls from faster than expected growth should be pre-committed and used in full to speed up deficit reduction or to increase surpluses in good times. The prospects for attaining sound budgetary positions improve when consolidation plans are based on credible commitments to reduce expenditure ratios and better expenditure control mechanisms. Finally, let me reiterate previous calls for high quality statistical data and sound statistical reporting, which are key for the prevention and correction of budgetary imbalances.

As regards structural reforms, the Governing Council stressed the importance of creating a fully operational Single Market and flexible product and labour markets in order to enhance the adjustment capacity of the euro area economy and its resilience to external shocks. Liberalising product markets to allow more competition would raise incentives for firms to invest and innovate, thereby raising productivity growth. Removing labour market rigidities and distortions in wage and price formation are key conditions for promoting more homogeneous cost and price competitiveness trends among euro area countries and for generating sustained output growth and job creation. In particular, wage increases should be guided, in general, by the trend in labour productivity growth, while taking full account of the present level of unit labour costs, in order to preserve or restore price competitiveness. Moreover, it is desirable that wage settlements move away from automatic, backward-looking indexation mechanisms. The successful implementation of reforms aimed at removing rigidities and inefficiencies in euro area countries would raise potential growth and employment prospects.

We are now at your disposal for questions.

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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: As regards 2007, investors seem to be split on what to expect next year. Could you maybe give some clarification?

Trichet: As far as our position of today is concerned, our posture is one of “strong vigilance”. At the last press conference, I mentioned that I would say nothing that would change market expectations as regards what would happen until the end of the year. Our position is crystal clear. Over and beyond this I would say that we will do all that is necessary to ensure price stability and be credible in delivering price stability, in order to remain fully in line with the solid anchoring of inflationary expectations, as I have underlined twice in my introductory remarks. I will give you no other message for our decisions after our next meeting other than “we will do all that will be necessary to do”. I will of course comment on the position of the Governing Council at the next press conference in December.

Question: How effective do you think the ECB policy is at controlling monetary aggregates and – maybe, to put it a little bit more provocatively – is where we are now where the ECB wanted us to be in terms of monetary aggregates today? And the second question also has to do with the monetary side: I understand it would be a mistake to look at one pillar in isolation of the other, but if we just look on the monetary side of the fence right now, would you say that the situation we are in now clearly points to a need for further tightening in 2007 just on the monetary side? And a final question on inflation. You and other ECB officials have mentioned that this dip in inflation is likely to be temporary. Do you feel that it reduces the risk of core inflation trailing after headline-inflation – upwards?

Trichet: A number of questions. First remark: we have a two-pillar strategy. We look at the economic analysis, we cross-check with the monetary analysis and we make a judgement on the basis of a thorough examination of our two pillars. The monetary pillar has played a very important role. I want you to remember the time when we were called upon by a number of institutions or analysts not to increase rates. We then increased rates in December of last year. It was because cross-checking with the monetary pillar was clearly indicating to us that we had to increase rates. And again, a lot of observers, many economists and some institutions were advising us, on the basis of their own economic analyses, not to do that. So once again: the monetary pillar is important for us and has played, is playing and will continue to play, an important role in guiding our own decisions in a pragmatic way, as has always been the case. It is clear that the latest indications we have of monetary developments have not confirmed what we had seen some months ago when, as you may remember, M3 growth was starting to decline progressively. Let me give you the exact figures: for the evolution of M3 growth, we had 8.5% in June, followed by 7.8% in July when we could see that we had something which was suggesting that perhaps there was the start of a slowdown. And then we had 8.2% in August and now, today, we have 8.5%, back to the June level. So we can see clearly that we have important information coming from the monetary pillar. On the components, we nevertheless see the influence of our monetary policy tightening, because M1, as you know, is now somewhat less dynamic. The three last figures we have on M1 are 7.4%, 7.2% and 7.1%, which suggest that the most liquid component of M3 is a little less dynamic. And this, of course, is fully in line with our increase of interest rates. As I have said, we look very carefully at all the components of the monetary pillar and at all its counterparts. As far as counterparts are concerned, we have very dynamic credit growth, particularly credit to the private sector, households and the corporate sector. All this calls for very careful monitoring, as I have said before.

On 2007, I will confirm to you that we will do what we have done in the past, namely whatever is necessary to deliver price stability and to be credible in the delivery of price stability. And I will see you at the next press conference and comment on our analysis in December.

As regards inflation, I have said that we are experiencing a decrease in headline inflation. It is transitory. I expect that at the end of the year and beginning of next year, when we have the figures for December, and then those for January, that we will probably be at a substantially higher level, because we have those base effects, and a number of phenomena that create volatility in this domain. What we look at ourselves, of course, is not yesterday’s inflation or that of the day before. It is inflation over a period of, say, one-and-a-half to two years, because that is our own medium-term horizon, and beyond. Again looking at this horizon and beyond, we will do all that is necessary to ensure price stability that is in line with our definition of price stability, namely less than and close to 2%. Thus far, thanks to our credibility, the anchoring of inflation expectations has been in line with our definition of price stability.

Question: A different subject. Today we read in Germany’s most important newspaper, the Bild Zeitung, a horror story about the euro. Do you think it is a horror story really? Do you think it is a good communication policy on the part of the Eurosystem central banks to wait until such information, which must obviously have been there since June, is picked up by the boulevard press and makes people afraid? Or would it be better to come out with a sober explanation of what is happening and avoid that?

Trichet: First of all, we are extremely attached to the credibility of the notes themselves, which are very reliable and very much appreciated by the public and the users – our 313 million fellow citizens. The Bundesbank published at 12.30 p.m. today a communiqué which explains what the Bundesbank and the Eurosystem understands about what might have happened. I would only draw your attention to the fact that, according to present knowledge, we have 1,500 notes that were fragile and “fragilised” by a phenomenon, which I will come back to later, out of a total of 10.5 billion notes in circulation, 5 billion of which are in Germany, as Germany is particularly keen on notes. So, with this order of magnitude, it is fortunately a very small proportion of all notes. This incident has absolutely nothing to do with the production of the notes or with the printing works. What comes out of the first analyses that have been made is that it looks like these notes have been weakened by an acid impregnation. The Bundesbank, as is absolutely normal, shipped those notes to specialist laboratories at the Federal Criminal Investigation Offices in Berlin and Mainz for further examination. This examination concluded that nothing in the production of the notes was in question: not the paper mill, and not the printing works. There are a number of assumptions as to what happened exactly, and why these notes were plunged into an acid. I do not want to elaborate too much on that, because there are still investigations under way and we will see exactly what it is all about. But it cannot be excluded – but I say that with great caution – that these notes had been stolen, were impregnated with a certain liquid at the moment of the criminal action and were then impregnated with other chemical products in order to eliminate the initial impregnation of chemicals aimed at preventing any further use of the stolen notes. Let me explain: when you bring notes from one safe to another or from one vault to another, you have sometimes a mechanism which impregnates the notes with red ink in order to prevent further use of the notes when they are stolen. It is a way of protecting notes against the possibility of being stolen. It is a well known process to prevent robberies. Again it is an assumption, and I draw your attention to the fact that I say this with extreme caution, but perhaps, after having being stolen, these notes, already impregnated with the first liquid, might have been attempted to be “cleaned” by the robbers and that operation might have weakened these notes. Again I say that with great caution: we will see exactly what has happened after the full inquiry. At present, I can say that we have no other information from other central banks of the euro area, but of course we will continue to follow all this very carefully. Again, it is fortunately a very small proportion. At the same time it does not call into question, in any respect, the credibility of the notes in circulation: I gave you the figures – 1,500 out of 5 billion in Germany. But we will continue to investigate. The Bundesbank has done a great job, and I will not subscribe to any criticism against the Bundesbank which did exactly what had to be done.

Question: Mr Trichet, I have two questions: did I understand your remarks on fiscal policy right, that you as the Eurosystem or ECB urge the governments to use any windfall profits to bring down deficits and not to spend these windfall profits in order not to have any pro-cyclical effects? And the second question is: there was a speech published last week on the ECB’s side by a board member about when to stop tightening, and in that speech there was a lot of speculation about the neutral interest rate, that the neutral interest rate might be higher this time than was thought before due to better economic effects. Two short questions on that: do you share that analysis and, second, I was quite struck by the fact that usually you say that the ECB does not use the concept of a neutral interest rate. So, perhaps you might elaborate on whether you have changed your mind?

Trichet: On the fiscal analysis I entirely confirm your analysis. We are clearly saying that the windfall profits that are coming from better than expected growth, which is the case in a number of countries and economies, should be fully pre-committed to diminishing the level of public finance deficit. And we also add that, for those countries that have a surplus, it should be allocated to augmenting the surplus in good times. So that is clear, and I entirely confirm what you have said.

I certainly confirm that we do not refer to a neutral rate in the Governing Council of the ECB and that we have not changed in any respect our concept of monetary policy, which has proved to be very efficient and has permitted us to have the credibility that you know. I would only say that this was a personal view of a member of the Governing Council, but it does not reflect at all the position of the Governing Council.

Question : Mr President, coming back to inflation. Given that oil prices have fallen 20% in the last three months, is there a good chance perhaps that next year you will already achieve your price stability target, and could you give us an insight into your view on what is likely to happen with inflation in 2008? Is it still likely to be over 2%?

Trichet: I will confirm that I will see you again at the next press conference following the Governing Council meeting in December, when we will have the projections, and that I will tell you then what our Eurosystem staff projections are. I also remind you that we do not underwrite the staff projections, whether they are ECB staff projections or Eurosystem staff projections. We look at them as an important input, and we also look at a number of other analyses. We make our judgement on the basis of all these inputs. At this moment, I would say – with some element of caution, because we will have the projections in December – that the likelihood of the level of the headline consumer price index, as an average, being above 2% this year is certain, and remains likely for next year, on the basis of all the information that I have at this moment. Of course, we do not reason in the short term, we reason in the medium term. We ensure that we deliver, in the medium term, price stability which is in line with our definition, namely close to but below 2%, and we do all that we have to do to deliver this price stability in the medium term.

Question: Because you have spoken about the stronger tax entries for the Member States, I will ask you a question about the Italian budget in preparation by the Italian government. My question is: does this correspond to your standards of large cuts in expenditure and small tax increases, or do you support the views of other governors, who have said that there are too many tax increases and not enough cuts in expenditure. And I have a question about the Italian Minister of Finance, who spent seven years here at the ECB. Do you agree with an Anglo-Saxon daily paper which put him, in terms of his performance, at the bottom of a list of all Ministers of Finance?

Trichet: I didn’t see the article in question, but I certainly deeply disagree. I’m judging the person, and he has a very important responsibility, an extraordinarily difficult responsibility, obviously, and that’s clear. Perhaps the paper in question was confusing the person with the difficulty of his job.

But let me tell you first that to the extent that we are looking at fiscal issues, I would say that in practically all of the areas concerned, and in practically all countries, we would probably say that we judge that further efforts should be made to diminish public expenditure. I have already said that several times here. One problem is the deficit and strict respect of the Stability and Growth Pact. There is another issue, which is the absolute level of public spending as a proportion of GDP. And we know that the level in the euro area is much higher than the average for the OECD countries or the G7, for instance, to take just two benchmarks from the constituency of industrialised economies. So there we know that we have a problem. We know that we tend to have higher levels of public spending than others, and of course, in the present world of increasing competition and profound and very rapid changes, this doesn’t work in our favour. So I would say that Italy would certainly be one of those countries where it would be appropriate to further reduce public spending. That being said, my present understanding of the situation in Italy – and I would say in that respect, as in all others, I am in full agreement with Mario Draghi – is certainly that what is extraordinarily important at the present juncture is that the Italian budget, with regard to the final result in terms of the deficit, is not in any way watered down, that it goes through the parliamentary process without being watered down, with the result at the end of the process being identical to what was introduced by the Minister of Finance and the government at the beginning. At this stage, I would say that this is absolutely key.

Question: You didn’t say anything about this tax increase which will cut growth in 2007.

Trichet: If you have less public spending, then you can have fewer tax increases. It is purely arithmetical. Of course, we always have, in all cases, a preference for this kind of solution – reducing public spending, but earmarking that reduced public spending as being for the reduction of the public finance deficit. And then, if anything is left over, you reduce taxation.

Question: I have two questions. First, I wonder if you could help us interpret some of the latest data on euro area growth, in particular some of the confidence indicators. Do you take the message from these indicators that growth is continuing at roughly the same pace as it has been for the first two or three quarters of this year? Or do you see in these indicators any sign of a slowdown? I noticed in the statement that you have actually highlighted the risk of the US slowdown. Have you become perhaps a bit more worried about the impact of a US slowdown on the euro area? And, secondly, a more specific question about inflation. Last time in Paris you told us you expected inflation in 2008 to come below 2%. You have not repeated that today. Was that deliberate?

Trichet: I would certainly hope so, but I do not want to anticipate our own projections, so we will see what our own projections are. All that we do is to permit, in the medium term, inflation to be in line with our definition of price stability. So, I would say I am not in a different mode from what I said in Paris in this respect.

As regards economic activity we have had a very good – I would say more than good – first semester; indeed it has been exceptionally favourable. We have also had a favourable period over the last, say, four quarters. I draw your attention to the fact that this vindicates, in a very clear way, our diagnosis which started in mid-2005 and was fully confirmed when we increased rates in December. And you remember we were criticised at the time: some were saying that we tightened much too early; others were telling us that the last quarter of last year’s growth was not flattering – which appears to be slightly true: now, after revision, it is 0.4%, while at the time it was estimated at 0.3%, which was mediocre. But now that we have the full perspective and can see what happened over the last four quarters – particularly over the first two quarters of 2006 – we see that we have been fully vindicated. As regards the second semester: as I said, we still expect robust growth – less flattering than in the first semester, which was absolutely exceptional, but it would remain substantial growth, certainly around potential, perhaps hovering a little over potential. We will see exactly what happens.

As regards the US slowdown, my colleagues and I mentioned that in our own deliberations; I told you a moment ago that it was something that we had to mention. At the present time, I would say that we are making the working assumption that this slowdown would be a soft slowdown. We are not making the working assumption that it could be a hard landing. I draw your attention to the fact that the direct and indirect trade impact on us – I said that in Paris – is not something which is too substantial. I quoted the figure of a 1% slowdown in the United States transmitting -0.2% for growth in the euro area, taking into account the direct effect and the echo effect on the rest of the world as well. That being said, it is of course linked to the fact that our trade with the United States is less important than is frequently assumed. The United Kingdom is more important for us than the United States – only to give you an example. Also to be taken into account is the fact that, at the global level, what we see is that the slowdown in the United States is partially or might be partially offset by continuous robust growth in a large part of the rest of the world, which creates an overall environment which remains quite dynamic, seen from the euro area standpoint.

Question: First, I wonder whether you could talk about this: in line with this idea of a US slowdown, there has been some talk recently of central bank diversification of foreign reserves. We had the UAE earlier this week reaffirming that they are going to up foreign reserves of euro to 10%. I wonder whether you could talk about the impact of that on the euro and on the course of monetary policy. And then I wonder if you could help me understand: in the statement you say “in particular, wage increases should be guided in general by the trend in labour productivity growth”. If I’ve followed that trend correctly, labour productivity growth is at a high, so I wonder what it is that you are saying here.

Trichet: As regards the various decisions that are taken by central banks as regards their reserve assets, we take exactly the same attitude as we take with all economic agents, all investors and savers the world over. We have no policy of encouraging any such holdings and no policy of discouraging them. We consider that each institution, each private or public agent has to take their decision, on the basis of their own analysis. What we have observed up to now has been a smooth and orderly evolution since the creation of the euro. I would say that provided it is a smooth and orderly evolution, we have no reason to comment on it.

As regards the second question that you asked, I would say that we have quite a diverse situation from economy to economy as regards labour productivity growth. This is a way to tell each particular economy in the euro area that they have to take into account their level and evolution of unit labour costs, the overall cost-competitiveness of the economy, and the arbitrage between insiders and outsiders on the labour market, when they devise their decisions on wages and salaries in particular. It is absolutely clear that any increase over and above what would be reasonable, taking into account the labour productivity progress, would hamper sustainable growth, hamper job creation and contribute to more inflation. So in the interest of the country in question, in the interest of the euro area itself, in the interest of ensuring price stability, it is advisable to follow the recommendation of a wise and sound posture.

Question: First of all, I believe for the first time here in the statement you have staked out your views regarding the increase in German VAT by noting that there will be some quarterly volatility here at around the turn of the year. When I combine that with your earlier statement that, if your assumptions and baseline scenario continue, it will be warranted to withdraw monetary accommodation, it is hard not to draw the conclusion that you see your baseline scenario continuing into January 2007. I don’t like to bang my head against the wall any more than the average person here on this subject, but I will simply give you an opportunity to perhaps tell us whether it would be wrong if we were to write such a thing.

My second question is just a follow-up on the labour productivity issue. It is very clear to me how this line is a cautionary note to certain parts, certain members, of the euro area. I have to say, though, if I were, say, a German metalworker reading this, I would say “We have had incredible labour productivity growth over the last few years and we have no problems with competitiveness”. It would be hard not to read that as a signal to seek a solid pay increase this year. Would that be a correct reading?

Trichet: As regards VAT, I don’t think we have changed the previous messages in that respect. The fact that we have mentioned VAT in Germany as influencing growth and also creating volatility associated with it was in the statement or in the questions and answers a number of times already in such press conferences. We have incorporated that in all our analysis since the decision was taken by the German government. And it is important of course that we take it into account. We will see exactly what happens. As you know, there is a mainstream analysis that suggests that we will have a hump in the last quarter of this year and then the bust after the hump. We will see exactly what happens. Further administered price increases are one of the risks that we are regularly quoting because we really believe that it is a threat that we have to take into account. When we look at the past, it has played a significant role in the inflation that has been observed until now. We will see exactly what happens. Again, it’s a risk – I hope very much that it will not materialise – but it is a risk.

As regards 2007, I have already said what I wanted to say. We will see exactly what our judgement is on the basis of the new projections, of the new figures that we will have, and of all the information that will be available. In any case, it is already being very predictable that you have little doubt on what we will do next month. So don’t be too demanding, frankly speaking. In any case you know that we never pre-commit in the medium term. Several times when our rates were at 2%, we were repeatedly asked “Could you guarantee that there will not be any increases in your interest rates over a considerable period of time?” You remember the wording. And we had said “No, we will not tell you that we will not move in the months to come because we are alert and we will do whatever is necessary to cope with risks and threats to price stability”. And the same, you remember, when we started increasing rates. There were a lot of requests to the effect “Why don’t you say that you will increase every month or every two months, regularly?”

We said “No, we are alert, we will see what has to be done, taking into account our analysis of the situation”. With the benefit of hindsight you see that it worked very well: we happen to be very predictable; and the market has understood - it seems to me – pretty correctly what we had in mind.

As regards labour productivity, let us take the example of this country that you choose – you have picked up on one particular country. I said that we have had the problem of inflation, we have the problem of competitiveness, and we have the problem of unemployment. At the present level of unemployment it is clear that this issue is very important. There is to be taken into account the interest of those whom I would call the outsiders, those who have no job today. It is an issue which is important in all countries as well as in Germany; it is not particularly a German problem. It is true that the productivity progress was quite good in the past in Germany and it is equally true that unit labour costs have moved slowly in comparison with the average, but it was justified by a catching-up exercise. You remember that for this particular economy, after reunification, cost-competitiveness was not satisfactory at all. The cost-competitiveness of this economy, Germany, had to catch up, which is being done, and is being done regularly, year after year. I would say that the main argument for wage restraint would certainly be today the level of unemployment.

Question: Let me follow up on the German VAT issue. It seems that there has been a hike in tobacco taxes. It is apparent that the announced VAT hike is affecting other fields. What do you think of this situation? Do you think it is very bad in terms of price stability? This is my first question. My second question: Mr Bini Smaghi, in Japan I think, told us that in the tightening cycle you sometimes have to be flexible in terms of the pace. Do you share that view, especially in view of the expected VAT hike in January? So do you think you have to wait and see a couple of quarters?

Trichet: What we have to deliver is price stability in the medium run and what I have observed in the past is that the contribution of administered prices on inflation has been substantial year after year after year – even if it seems bizarre, because we should not normally have to cope with such a big contribution of administered prices. But we have to take that into account, as it's undoubtedly a problem. I do not welcome, in general, administered price increases. And I would say that if some are augmented, for example I understand pretty well why tobacco should be augmented – there is absolutely no problem there, although I think that perhaps the smokers in this room would not be at all satisfied – but I would say for health reasons we can have good reason to do that. But then I would call for other prices to be reduced in order for us and for overall inflation not to be hit by these decisions. That being said, it is not my job to enter into fine-tuning such decisions, as they are the responsibility of the executive branches, but as a general rule we do not like at all their net impact on inflation.

As regards the mention of some consideration on cycles of interest rate hikes and so forth, I stick to what I have said. Everything you have seen or read or heard are personal views and have absolutely nothing to do with the views of the Governing Council which I am transmitting to you right now.

Question: My question is an economic question. Looking at the yield curve, it is extremely flat, also in the euro zone. It has a tendency to appear inverted, like in the United States. Traditionally this is a sign of an economic slowdown in the forecasting. Your analysis is for strong and robust economic growth, but I can also quote you as saying that over the longer term the risk to growth continues to lie on the downside. What is the message of the yield curve? Is the traditional message correct? Or is it also the product of over-liquidity, of many years of extreme money supply growth rate worldwide?

Trichet: This is one of the most important issues that we all have to deal with. On both sides of the Atlantic we have the same shape of yield curve, the same very low level of real rates, and the same extremely low level of nominal rates. It is true that we have – the last time I looked at the figures – ten-year euro rates on the Bund benchmark; we had 3.72%, which is extraordinarily low. The conclusion that we could draw from the yield curve as it stands is much disputed. And I would say that the majority of economists – certainly on the other side of the Atlantic but also on this side of the Atlantic too – would not say that the present slope of the yield curve means that there is a very high risk of recession. It is considered that you have to introduce a large number of other elements to conclude, and I said myself that our working assumption – which is shared, it seems to me, by the mainstream analysis and certainly by our friends on the other side of the Atlantic, in the sister institution – is that a soft slowdown is very likely. Now you will ask me how it is possible that there are such very low levels of long-term interest rates. But you have answered this question yourself, saying that it is the accumulation of past liquidity. I am not sure that this a fully appropriate explanation, or the only explanation. There is an element there, it is clear, and the fact that we have all increased rates means that – in any case – we judged that the previous monetary policy had become too accommodating at a certain moment. And we have gradually corrected that. But there is also another element which is certainly important: the creeping oil shock. For several years, every year, until most recently, there has been an increase in the price of oil, the accumulation of additional current account surpluses by oil exporters, and this has created – on top of what we had observed even before the creeping oil shock, on top of the global savings that existed before – an additional and significant volume of “forced savings” that are taken by the oil exporters out of the rest of the world and are creating an additional volume of capital chasing investments at a global level. This is not a normal way of looking at things, as you generally have investments chasing capital rather than the reverse.

When you have such capital chasing investment, it creates an environment where capital is abundant, and pushes down the price of risk in general. And that might explain in particular why we have such a low level of long-term rates on both sides of the Atlantic and everywhere in the world. And that would be totally independent from the long medium-term prediction by the market of what is likely to happen in the economies concerned. That being said, we will see exactly what happens. We work a lot to analyse the situation, to better understand the financial markets. As you know, we have the feeling that this cannot last forever, and that the present accumulation of the very low level of real rates, the very low level of spreads, the very low level of risk premium that we are observing, the underestimation of risks in general – will necessarily be corrected. Our present working assumption is that there will be a soft correction – not a sharp and abrupt correction. But, as I have said several times already, there will be a correction.

Question : I was wondering if you could help me to understand two of your statements. One is where you say that it is crucial for the social partners to continue to meet their responsibilities. I am wondering if there is some message here to companies as regards the way they manage profit margins in the context of expansion in the near future. Should they still be restricting them or not? Are you afraid that that might happen or not? My second question is: I was wondering if you could explain your thinking on this idea of a stronger pass-through from past oil prices into consumer prices. What might be the rationale to explain a stronger or less strong pass-through? And finally, in 2007 Portugal will probably be the only country with a budget deficit above 3%. Some pessimistic observers, like Standard & Poor’s, even say that we might even be above 3% in 2008. The Portuguese government made its budget proposal two weeks ago, but I do not know if you have had the opportunity today to take a look at the figures?

Trichet: “Social partners” means that one has to take into consideration everything that I have said on competitiveness, on the level of unemployment and on the need to maintain price stability, so I will not elaborate further. As regards companies, I would certainly call on companies to take into account the fact that they have a range of ways of financing themselves that is really very impressive. I see that they are now increasingly taking advantage of this favourable financial environment, because, the contribution made by gross capital formation to euro area growth is quite substantial. It is 0.9% over the last four quarters that are known, compared with a level of growth which is around 2.7%, so it is now a contribution which is in the order of magnitude of the contribution of private consumption. We really do have a level of investment which is becoming quite dynamic, and I would say in this respect that this is paving the way for the future, so this is good. As regards the pass-through – again, it is a risk. A stronger than expected pass-through means that we see an impact on prices that exceeds what is presently in our own understanding and projections. It is in the analysis of risks that we say that we might have to cope with a pass-through which is stronger than previously expected.

On Portugal, I would only say that Portugal has to strictly observe the Stability and Growth Pact. This is a principle that we consider to be very important for everyone. To my knowledge, this is agreed upon not only, of course, by the Commission – that goes without saying – but also by the Council. The problem, again, is delivery.

Question: Two short questions. Firstly, I would not dream of asking you again what you plan to do in 2007, but perhaps I could ask you a more general question to also help us to understand better your communications strategy. How helpful do you think it is for central banks to signal when they are reaching the end of a tightening cycle, and how wary do central banks need to be of stopping too soon? And a second question about global imbalances and the yen in particular: do you share the view that the yen should better reflect economic fundamentals?

Trichet: On the first point I will not say anything more than I have already said. You can observe what we have done in the past. In the past, we had a long period of time with a level of 2% during which we did not move. We communicated very clearly with the markets, so I think that there is absolutely no problem: when you decide, you communicate and the market understands pretty well what you are doing. I am very clear that we will do in 2007 exactly what is needed to deliver price stability and to be credible in ensuring price stability. As regards the second question on the yen, I already said what I thought on this particular issue on the occasion of the G7 meeting in Singapore, and I would say that nothing today would drive me to change what I have already said.

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