Introductory statement with Q&A
Jean-Claude Trichet, President of the ECB,
Lucas Papademos, Vice President of the ECB
Frankfurt am Main, 4 September 2008
Ladies and gentlemen, the Vice-President and I are very pleased to welcome you to our press conference. We will now report on the outcome of today’s meeting of the Governing Council, which was also attended by Commissioner Almunia.
On the basis of our regular economic and monetary analyses, at today’s meeting we decided to leave the key ECB interest rates unchanged. The information that has become available since the last meeting has confirmed that annual inflation rates are likely to remain well above levels consistent with price stability for a protracted period of time and that upside risks to price stability over the medium term prevail. While the growth of broad money and credit aggregates is now showing some signs of moderation, the still strong underlying pace of monetary expansion points to continued upside risks to price stability over the medium term. The latest economic data also confirm the weakening of real GDP growth in mid-2008. This reflects partly an expected technical reaction to the strong growth seen in the first quarter as well as dampening effects from global and domestic factors, including direct and indirect effects from high commodity prices. In this environment, it remains imperative to avoid broad-based second-round effects in price and wage-setting. In full accordance with our mandate, we emphasise that maintaining price stability in the medium term is our primary objective and that we are resolute in our determination to keep medium and long-term inflation expectations firmly anchored in line with price stability. This will preserve purchasing power in the medium term and support sustainable growth and employment. On the basis of our assessment, the current monetary policy stance will contribute to achieving our objective. We will continue to monitor very closely all developments over the period ahead.
Allow me to explain our assessment in greater detail, starting with the economic analysis.
According to Eurostat’s first estimate, following strong quarterly growth of 0.7% in the first quarter, euro area real GDP contracted by 0.2% in the second quarter of 2008. In terms of quarter-on-quarter growth, private consumption declined by 0.2% and there was a perceptible weakness in investment, which fell by 1.2%. Growth in both euro area imports and exports declined by 0.4%.
Taking into account all available information, the euro area economy is currently experiencing an episode of weak activity characterised by high commodity prices weighing on consumer confidence and demand, as well as by dampened investment growth. We expect this episode to be followed by a gradual recovery. In particular, if persistent, the fall in oil prices from their peak in July will help strengthen real disposable income, with the level of employment remaining high and the unemployment rate low by historical standards. Moreover, growth in the world economy is expected to remain relatively resilient, benefiting mainly from sustained growth in emerging economies. This should support external demand for euro area goods and services and thereby investment.
This outlook is also reflected in the September 2008 ECB staff macroeconomic projections for the euro area. The exercise projects average annual real GDP growth in a range between 1.1% and 1.7% in 2008, and between 0.6% and 1.8% in 2009. In comparison with the June Eurosystem staff projections, real GDP growth figures for 2008 and 2009 are lower.
In the view of the Governing Council, the uncertainty surrounding this outlook for economic activity is particularly high at the current juncture and, generally, downside risks prevail. Risks stem particularly from renewed increases in energy and food prices, which could dampen consumption and investment. Moreover, downside risks continue to relate to the potential for the financial market tensions to affect the real economy more adversely than currently foreseen. The possibility of disorderly developments owing to global imbalances also implies downside risks to the outlook for economic activity, as do concerns about rising protectionist pressures.
With regard to price developments, annual HICP inflation has remained considerably above the level consistent with price stability since last autumn, standing at 3.8% in August according to Eurostat’s flash estimate, after 4.0% in June and July 2008. This worrying level of inflation is largely the result of both the direct and indirect effects of past surges in energy and food prices at the global level. Moreover, wage growth has been picking up in recent quarters, at a time when labour productivity growth has decelerated, resulting in sharp increases in unit labour costs.
Looking ahead, on the basis of current commodity futures prices, the annual HICP inflation rate is likely to remain well above levels consistent with price stability for quite some time, moderating only gradually during the course of 2009. Consistent with this view, the September ECB staff projections foresee average annual HICP inflation at between 3.4% and 3.6% in 2008, and between 2.3% and 2.9% in 2009. The higher inflation projections for 2008 and 2009 mainly reflect higher energy prices and, to a lesser extent, higher food and services prices than assumed previously.
In this context, it is important to recall the conditional nature of the ECB staff projections. They are based on a number of assumptions that are of a purely technical nature and unrelated to policy intentions. In particular, the technical assumptions for short-term interest rates reflect market expectations as at mid-August. Moreover, it should be noted that the projections are based on the assumption that oil and non-oil commodity prices, while remaining at elevated levels, will exhibit greater stability over the projection horizon than has been the case in recent months, in line with prevailing futures prices.
It is the Governing Council’s view that, at the policy-relevant medium-term horizon, there are upside risks to the outlook for price developments. These risks include the possibility of renewed increases in commodity prices and of previous rises having further and stronger indirect effects on consumer prices. There is particularly a very strong concern that the emergence of broad-based second-round effects in price and wage-setting behaviour could add significantly to inflationary pressures. Moreover, the upside risks to price stability could be aggravated by unexpected rises in indirect taxes and administered prices.
Against this background, it is imperative to ensure that medium to longer-term inflation expectations remain firmly anchored at levels in line with price stability. Broad-based second-round effects stemming from the impact of higher energy and food prices on price and wage‑setting behaviour must be avoided. The Governing Council is monitoring price-setting behaviour and wage negotiations in the euro area with particular attention. All parties concerned – in both the private and the public sectors – must meet their responsibilities in this regard. The Governing Council has repeatedly expressed its concern about the existence of schemes in which nominal wages are indexed to consumer prices. Such schemes involve the risk of upward shocks in inflation leading to a wage-price spiral, which would be detrimental to employment and competitiveness in the countries concerned. The Governing Council calls for these schemes to be abolished.
The monetary analysis confirms the prevailing upside risks to price stability at medium to longer-term horizons. In line with our monetary policy strategy, we take the view that the sustained underlying strength of monetary and credit expansion in the euro area over the past few years has created upside risks to price stability. Over recent quarters, these risks appear to have become manifest as inflation has trended upwards.
Not least in the face of the ongoing tensions in financial markets, the monetary analysis helps to support the necessary medium-term orientation of monetary policy by focusing attention on the upside risks to price stability prevailing at medium to longer horizons. While the growth of broad money and credit aggregates is now showing some signs of moderation, reflecting the policy measures taken since 2005 to address risks to price stability, the strong underlying pace of monetary expansion points to continued upside risks to price stability over the medium term.
The currently flat yield curve has given rise to a substitution from longer maturity assets into monetary instruments, which offer similar remuneration but greater liquidity and less risk. This substitution has led the current headline rate of M3 growth to overstate the underlying pace of monetary expansion. At the same time, shifts out of overnight deposits drove the annual growth rate of M1 down further in July. These effects, as well as other temporary factors, must be taken into account when assessing monetary developments and their implications. A broad-based analysis of the data, taking the appropriate medium-term perspective and allowing for these considerations, confirms the underlying strength of money growth.
In particular, the pace, maturity and sectoral composition of borrowing from banks suggest that, at the level of the euro area as a whole, the availability of bank credit has, as yet, not been significantly affected by the ongoing financial tensions. This notwithstanding, growth in loans now shows signs of moderation, as previously anticipated, with corporate demand for credit slowing. At the same time, the growth of loans to households continues to follow the downward trend observed over the past few years, as a result of higher short-term interest rates and housing market weakness in several parts of the euro area.
To sum up, a cross-check of the outcome of the economic analysis with that of the monetary analysis clearly confirms the assessment of upside risks to price stability over the medium term. The information that has become available since the last meeting of the Governing Council has confirmed that annual inflation rates are likely to remain well above levels consistent with price stability for a protracted period of time. The growth of broad money and credit aggregates is now showing some signs of moderation, but the still strong underlying pace of monetary expansion points to continued risks to price stability over the medium term. The latest economic data also confirm the weakening of real GDP growth in mid-2008. This reflects partly an expected technical reaction to the strong growth seen in the first quarter as well as dampening effects from global and domestic factors, including direct and indirect effects from high commodity prices. Against this background, it remains imperative to avoid broad-based second-round effects in wage and price-setting. In full accordance with our mandate, we emphasise that maintaining price stability in the medium term is our primary objective and that we are resolute in our determination to keep medium and long-term inflation expectations firmly anchored in line with price stability, thereby preserving purchasing power in the medium term and supporting sustainable growth and employment in the euro area. On the basis of our assessment, the current monetary policy stance will contribute to achieving our objective. We will continue to monitor very closely all developments over the period ahead.
Regarding fiscal policy, budget plans for 2009 should fully reflect existing policy commitments. This implies that euro area countries with relatively large fiscal deficits need to specify much more ambitious and concrete consolidation measures, especially on the expenditure side. Countries that have already achieved their medium-term budgetary objectives need to ensure that they maintain sound structural fiscal positions. At the current juncture, the steady pursuit of stability-oriented fiscal policies would help to contain inflationary pressures and provide the required budgetary room for manoeuvre to allow automatic stabilisers to contribute to smoothing the business cycle.
Turning to structural policies, measures that reduce adjustment costs and promote moderate unit labour cost growth are of the utmost importance in the current economic circumstances. While this is crucial in all euro area countries, it is particularly pressing in those that have experienced a significant loss of cost and price competitiveness over recent years and where unemployment has already started to rise. Moreover, fostering productivity through enhanced investment in innovation and education enlarges the scope for increases in real incomes in the longer run.
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: Monsieur Trichet, can you just briefly clarify the growth projections, because there seems to be some confusion. We have taken the GDP growth projections of 1.1-1.7% for 2008 and 1.6-1.8% for 2009.
Second, I would like to ask you the standard question at this stage: do you have a bias?
And, if you do, what is it? And, also, did you debate and come to a conclusion on the changes to the ECB’s collateral framework?
Trichet: As regards your first question, at the end of this press conference you will receive the usual press release on the staff projections. Let me only restate that these are the staff projections. They are an important input for the Governing Council. But as you know we do not underwrite the staff projections ourselves. To respond very clearly to your question on GDP for 2008 – the new staff projections are from 1.1% to 1.7%; and for 2009 they are from 0.6% to 1.8%.
On the second question, which was, as you said, the “standard question”, it is important to note that we consider that the present monetary policy stance will contribute to achieve our goal, which is the delivery of price stability over the medium term. We concentrated in our discussion at today’s meeting on one option, which was maintaining rates at their present level. We were unanimous in making that decision and, I would say, we are in exactly the same mood as at the last meeting of the Governing Council, as indicated during the last press conference when I expressed our position. We have exactly the same position. We have no bias. That being said, we are never pre-committed and we always do what is necessary to deliver price stability in the medium term and to be credible in that delivery. Being credible in that delivery permits the anchoring of inflationary expectations, and I emphasised the importance of that point.
On the ECB’s collateral framework, perhaps I could reserve your question until later because we have a decision to announce today, which I will do at the end of the press conference.
Question: On the point of inflation, we clearly have some relief on the inflation front, especially when you look at consumer prices. Some of the lagging indicators, like producer prices, are still very troublesome and some other indicators are actually the mixed blessing of the euro coming down in its value. We get imported inflation through import prices. So, to what an extent have your inflation considerations changed? Do you think that we’ve got more danger, less danger? To what an extent is that weighing on your considerations now?
Trichet: As regards the judgment of the Governing Council, I will sum it up in saying that the risks to price stability that we see are exactly what we saw at the last meeting and they are on the upside. We have upside risks to price stability – we are clear on that. As you will recall, we have only one needle in our compass, which is the delivery of price stability. If I had a message that were a little bit different from the last meeting, I would say that the Governing Council particularly insists on the necessity to avoid second-round effects, both on the side of the price-setter in general and on the side of the social partners. In this domain, we are calling on all parties very strongly to avoid those effects. We are making that point not only because it would create a big problem for delivering price stability and hamper in the medium and long term the purchasing power of our fellow citizens, but it will also play against employment. And that is something the Governing Council wants to particularly stress.
Question: First of all, are we now closer to a recession, would you say?
My second question is whether you, like your colleague, Mr Stark, see broad-based, second-round effects in the euro area?
And, finally, do you think that market expectations for no change to rates this year are appropriate?
Trichet: The projections, as I said, are the staff projections, we do not underwrite these projections. They are an important input, but we also look at the other analyses that are made by the public and private sector. You have the figures in front of you; so you can see the figures produced by staff with regard to average growth. Neither the average growth figures for this year, nor those for next year, are negative. As regards the profile of growth, the Governing Council is observing what is going on, and it is very much in line with what we said before. We said a month ago that we would see a trough in the profile of growth in the second and third quarter. And this is what we are observing. The sentiment of the Governing Council is that, after this trough, we will have a gradual recovery.
As regards broad-based, second-round effects in the euro, we are clearly signalling that our main message is precisely to avoid broad-based, second-round effects. We have seen some second-round effects, but not broad-based ones. Our message is absolutely clear: broad-based, second-round effects have to be avoided, because they would lead to all of the consequences I have already mentioned. In other words, they would not permit us to achieve price stability or to consolidate the success of the euro area in terms of job creation and current levels of employment. So, we are in a mode of preventing broad-based, second-round effects. We have observed some second-round effects, particularly in those economies that have in-built indexation mechanisms. These are particularly adverse in the present circumstances, because the second-round effects are being introduced precisely by way of such mechanisms.
As regards your third question whether market expectations for no change to rates this year are appropriate, to the market, I repeat: we have no bias. Equally, we never pre-commit and we always do what is necessary to deliver price stability.
Question: So, if I have got these inflation projections right, at no point in the next two years do you anticipate that inflation will be in line with your definition of price stability? Do I have that right, and if I do, then when do you see inflation being in line with your definition of price stability?
Secondly, you have said you have no bias. Why not? You have got inflation at above your definition of price stability for the next two years and you have said that risks are to the upside.
And finally, one of your colleagues recently described interest rates at the moment as accommodative. Would you repeat that?
Trichet: First of all, with regard to my colleague’s declaration, as you know, I am the only one who speaks on behalf of the Governing Council. So I draw your attention to that slight difference. Many colleagues might make remarks that are very useful, very interesting and stimulating, and also very adapted to the environment in which they find themselves. Indeed, I think it is important that what we communicate is adapted as much as possible to various circumstances. However, as regards the position of the Governing Council, I suggest that you follow what I say on behalf of the Governing Council, of course.
As regards your question why we do not have any bias, we have just increased interest rates and we increased them precisely to be sure that, taking into account the risks that we see, we can cope with those risks, offsetting them as much as possible. Again, the position of the Governing Council is that the present monetary policy stance will contribute to achieving our objective and delivering price stability in the medium-term.
With regard to the precise moment of delivery of price stability in line with our definition, we consider that we will deliver price stability in the course of 2010. I do not want to be more precise but I say clearly that this is when we will deliver price stability.
Question: You said that the high oil prices not only have impacts on the business cycle, real activity, but also on growth potential. Could you elaborate a bit on the logic behind that? And maybe you can give us some hint on what level you consider growth potential to be at right now.
And the second question is: apparently the oil price has a strong impact on your projections, or the projections of the staff. Can you tell us something about the weight of the oil price in these calculations?
Trichet: On growth potential, it is a pertinent remark of economists that when you have a big change in relative prices, as it is the case, there are a number of phenomena that appear, including the fact that part of the stock of capital becomes, for various reasons, partly obsolescent, and then you undoubtedly have a shock to growth potential. I mention that because I think it has to be in our minds. I cannot give you at this stage a position of the Governing Council as regards the degree to which we would consider that - at the moment at which we are speaking - growth potential has diminished. It’s not a phenomenon which would hit particularly the euro area. It’s a phenomenon which would hit all economies, because it would be a shock of the same nature for all economies. So it should not be considered negligible. It is something which must be significant, but we have no position of the Governing Council on a new revised level of growth potential.
As regards oil prices, we are in a situation which is really a universe of great volatility, as one sees. All forecasters, all economists that are embarking on the difficult exercise of projections have exactly the same problem, whether they are from public or private institutions, and it’s clear that the price of oil and commodities has a big impact. It’s also clear that all institutions have their own methodology. But the methodology that I have found to be the most common is not perfect, obviously, because it consists in having a snapshot of prices at a certain moment, with a certain deadline, generally in having some kind of average of the days preceding a deadline. It is what our staff does. And then you take the futures. But the futures market is going up and down as does the spot market, with a slope which is changing from time to time. So, again, it’s true for the staff projections of the ECB as well as for all projections: they are highly conditional.
Question: Mr Trichet, you’ve warned in the past against brutal moves in foreign exchange rates. Are you concerned by the sharp moves that we’ve seen in the euro over the past couple of months?
And my second question is: you picked up on the sharp decline in M1 money growth. Do you draw any particular message from that?
Trichet: On the exchange rate I will repeat what you know to be my position. I have noted with extreme attention that the US authorities have said that a strong dollar was in the interests of the United States of America, and I see that this declaration is believed by a number of operators and market participants. And I will again echo what is said by the US authorities themselves, which I have always considered to be very important, even at a time when perhaps market participants were less attentive to what was said.
As regards M1, M2 and M3, I said on behalf of the Governing Council that we see in the growth differential between the various monetary aggregates the influence of the very particular yield curve that we have today. And the dynamism of M3 is partly due to the fact that this yield curve is flat and that a large proportion of investors are not taking the risk to be longer. It’s also clear that, as regards M1, the present constellation of rates calls for M1 to be very moderate in its behaviour. Since we are addressing the issue of the monetary aggregates, on the counterparts of the monetary aggregates I will only mention that the figures we still have for yearly growth of the outstanding loans to non-financial corporations are at the level of 13.2%, last month it was 13.6%. So we see the tendency to diminish, but it remains very robust: a multiple of the growth of GDP in value terms. And this is one of the reasons why I said that we don’t see as yet a significant correction of these dynamics that could be interpreted as associated with the financial turmoil.
Question: Regarding the euro, what consequences do you expect for growth and inflation as a result of the deceleration of the euro? Will this actually make the euro area more competitive in international markets?
My second question refers to inflation: we have heard from one of your colleagues that the Governing Council is not sure that the price stability goal of 2% will be met on average in 2010, and you have just said that you are looking at delivering price stability during the course of 2010. Am I therefore right in understanding that you are suggesting that average annual inflation in 2010 will be above 2%?
Trichet: I will only say that we will be back to our definition of price stability during the course of 2010. I am not going to qualify the average. Again, I will say very clearly that we take decisions as and when they are needed in order to deliver price stability in the medium term. We increased rates very recently, precisely in order to reach that goal. We will do what is necessary to reach the goal of achieving price stability in the medium term, and I think we have proved we are credible when we say this.
Concerning the consequences that we expect for growth and inflation as a result of the deceleration of the euro I already said everything that I have to say on growth and inflation themselves. It is of course important to synthesise the numerous factors that are influencing both growth and inflation. And I have already given you our position regarding these factors.
Question: Following up on the question about potential growth: if it is likely that euro area potential growth has fallen, does that mean it will be wrong to assume, as maybe many might, that the current episode of weak growth would automatically by itself reduce inflationary pressures?
My second question – a slightly shorter-term issue – oil prices have been falling quite sharply recently, how quickly do you think that could have an effect on quarterly growth rates in the euro area?
Trichet: As regards the fall in potential growth, it clearly means that whatever rate of growth you observe at a certain moment, all other things equal, the so-called output gap would be weaker in the case of decreased potential growth than it would have been had potential growth not decreased. It therefore clearly has an impact on the assessment of the absence of inflationary pressures that is associated with a weak episode in growth. For this reason, we think it is important to have that in mind, even if I was very cautious and prudent, as you can see in terms of the assessment of the quantity of the figures.
As regards your second question, we are very cautious and prudent in this respect. The kind of volatility that we are seeing on the oil and commodity markets is exceptional. It is a very complex combination of underlying drivers. Demand has very much been driving prices over the past few years. But we should not neglect the fact that there are also all the elements that could characterise a cartel. The question of supply is therefore an open question which is also extremely important and might have been more important in the recent period, marked by the spike in oil prices. There is also the financial market element that has played a role: a lot of investors have decided to diversify their portfolios and have started to purchase instruments representing commodities, including oil, in the futures market. This might be one of the additional reasons why we are observing such hectic behaviour on commodities markets. At this stage, I would say again that all projections are based on a certain methodology. I accept that this methodology is theoretical, and, in a universe that is extraordinarily uncertain, we have to recognise the fact that it is highly theoretical, but we do not have any other means to be objective in trying to take into account the future. Therefore, I would only say at this stage that, even with the recent slowdown in the price of oil, there is still the possibility of new spikes, which I hope will not be observed as it would be very bad for the global economy, for inflation and for all parties concerned. I therefore urge all partners, irrespective of whether they are involved in the demand side or in the supply side, to be responsible. I am speaking not only for oil producers that are emerging countries, but also for all producers that are in the industrialised world. I also said this two months and three months ago. I therefore urge them to be as responsible as possible because there is a common interest in the global economy. I also think that those who have invested massively in those instruments representing commodities need to ensure that they are not embarking into any kind of bubble. So again, I have this message, but I am not going to embark on a sensitivity analysis of whether the price of oil will go up or down.
Question: The inflation expectations derived from five-year forward inflation swaps have been something around 2.6%, 2.7% recently. How important is that in formulating the policy stance of the Governing Council?
Trichet: It is one of the elements we look at very carefully. We also look, at the break-even on a five-year basis, the break-even on a ten-year basis, but, the five-year forward break-even in five years is certainly one of the important indicators. It is complex because it incorporates risk premia on top of inflation expectations, and you know that analysts are working a lot to try to disentangle the information on risk premia and on inflation expectations which are contained in this break-even concept. We also have other ways of looking at inflation expectations, including the surveys. However, the reason why I emphasised the fact that a solid anchoring of inflationary expectations in line with our definition of price stability is for us absolutely key is that we see, under the global circumstances that we have to cope with, a tendency for these measures of inflation expectations to creep up. This is true for the surveys and forecasts as well as for the break-even that we extract from financial markets. There is also something which we look at very carefully, which is that after the recent decrease of the price of oil we saw a very significant decrease of the break-even that we extract from the five-year bond, and a very significant decrease of the break-even that we extract from the ten-year bond. So both five-years and ten-years were decreasing, but the five-year forward break-even itself was quite steady at a level which we do not consider satisfactory.
Question: One more economic or scientific question. Recent studies in the United States showed that the transmission mechanism is getting less and less powerful as banks just build up their own capital markets internally and are much less sensitive to increases or decreases in interest rates or just changing the monetary base, the central bank money. Is that in line with your experience in your research for the euro zone?
Trichet: We are all working very much on the transmission channel. As you know, there are many transmission channels, including the credibility channel. And the anchoring of inflation expectations that we just mentioned is absolutely decisive in this respect. So there are differences on both sides of the Atlantic. I would say at this stage that what we have observed in the banking sector until now – and I am prudent and cautious – does not signal that we have a banking sector which is, at this moment in time, hampered by its level of capitalisation. So we might not observe on this side of the Atlantic the same kind of developments that are observed on the other side.
Question: First of all, you gave an answer to two questions. You mentioned a couple of things about the projections. One is that they are very highly conditional and the other is, in that context, that by 2010 you will do what is needed to restore price stability. There is a tendency among financial market observers to derive from the mid-point of the staff inflation forecast what you are going to do in the following year with interest rates. Would it be correct to derive from what you have said about the forecasts and their conditional nature that that is not a proper assumption?
My second question to you has to do with the fact that we will all have the chance to talk about the idea of a recession in the euro zone, depending on what the third quarter GDP numbers do. Of course, that is an important concept from across the Atlantic, and it has never been as straightforward as simply two quarters of contracting GDP. So I wondered if you could elaborate on whether you think this is a sensible guide for the euro zone – I know it has not been always used that way – and whether it feels like there might be a recession in the euro zone as a whole.
Trichet: As regards the assumption that market participants or traders or investors can make, I leave to them the responsibility of their assumption. As far as we are concerned, as you know we are never pre-committed. We do what we believe is necessary at any time, and we have proved that in the past, including in the very recent past. Again, we will do what is necessary in an environment which is changing. We see as regards the inflationary risks that they are on the upside. We also believe that the decision we took two months ago and therefore the present monetary policy stance will contribute to delivering price stability in the medium term.
As regards the profile of growth, I have said already – and there is full confirmation of this, and again, it is nothing new – that the second and third quarters are a trough in the profile. I will not embark on any qualification of the technical definitions of the situation. I have no particular comment on that, but we are in a trough, that is absolutely clear, and progressively we will see a gradual recovery.
Question: Back in spring one had the impression that the United States was heading towards a recession and would experience a severe downturn, while the euro area would not be affected as badly. Looking at the situation now, it seems that the likelihood of a recession is even greater in the euro area than in the United States, and I’m wondering whether that has, in your opinion, anything to do with the macroeconomic policies on the two sides of the Atlantic – not only monetary policy, but also fiscal policy – and whether you think the US authorities were right to react as aggressively as they did?
Trichet: As regards Europe, and we are speaking for Europe, four months ago we pre-announced that we were, after a brilliant first quarter, experiencing a trough. We said this because it was clearly our sentiment as regards the profile of growth. So again we are not surprised. There is no judgement on what is being done on the other side of the Atlantic. They have their own decision-making process. I don’t make any judgment on their fiscal policy and as you know certainly not on their monetary policy. However, I would mention one thing: there is a difference between the two sides of the Atlantic: We are balanced in particular as regards the crucial relationship between savings and investment, domestic savings and domestic investment. On the other side of the Atlantic, even though some progress has been made, there are still significant imbalances.
Question: You said that you were unanimous in your decision today, but you mentioned that there were two options on the table, if I heard correctly.
Trichet: No, I said “one”.
Question: Just the one?
Trichet: We concentrated on one.
Trichet: Let me now tell you what the Governing Council has decided today as regards the control measures in the Eurosystem credit operations.
As you know, we have a way of reviewing our framework every two years, and the previous reviews were reflected in the risk control framework and the General Documentation that we published in 2004 and 2006.
So the present set of decisions, they are the following:
As regards ABSs, we have decided to apply to asset-backed securities a uniform haircut of 12% for all residual maturities and all coupon types. So 12% across the board. I have to mention that we are not, then, increasing haircuts for all ABSs, because we had already applied a 12% haircut to some ABSs – ABSs with a fixed coupon and a residual maturity of more than ten years. And for ABSs with a zero coupon and such residual maturity – the haircut so far has been 18%. But it is true that for ABS with lower residual maturity, the Eurosystem is now increasing haircuts.
Still on the ABSs, we have decided to apply a haircut add-on to ABSs that are theoretically valued, in the form of a valuation markdown of 5%. The valuation markdown is applied to the theoretical price before the application of the 12% haircut. The total discount on the price is then exactly 16.4%, when you compute first the 5% and then the 12%.
On bank bonds, we have decided to apply a haircut add-on of 5% to unsecured bank bonds.
As regards close links in ABS transactions, we have decided to prohibit the submission as collateral of any ABS by a counterparty when this counterparty - or any third party that has close links to it - provides support to that ABS by entering into a currency hedge with the issuer or guarantor of the ABS or by providing liquidity support of more than 20% of the asset-backed security’s nominal value.
We have also introduced a new decision on the ratings, and we want higher rating disclosure standards. With regard to the External Credit Assessment Institutions, the so-called ECAI sources, the credit assessment must be based on a public rating. For ABSs, ratings must be explained in a publicly available credit rating report, being a detailed presale or new issue report, including inter alia a comprehensive analysis of structural and legal aspects and a detailed collateral pool assessment. So this involves the External Credit Assessment Institutions. Moreover, we would ask the External Credit Assessment Institutions to publish rating reviews for ABSs at least on a quarterly basis.
So these are the precise decisions that we have taken.
I will only mention that we will make more explicit in the General Documentation the discretion of the Eurosystem in excluding or limiting the use of certain assets, also at the level of individual counterparties. This is in line with Article 18.1 of the ESCB Statute. But we will certainly stress that.
What I can say on these measures is that they were designed to refine particular elements of our risk control framework. We wanted to ensure that the Eurosystem remains adequately protected against the observed changes in financial markets. These measures, as you see, do not change the general characteristics of the Eurosystem’s collateral framework, and, in particular, there is no change in the eligibility status of any asset type currently accepted in Eurosystem credit operations. And I have to say that – and this is the reason why we are not changing the structure of our framework – we consider that it has served us very well, particularly since the beginning of the financial turbulence. I have said to you before that we had not to change our collateral framework. And we are not changing it. We are refining it, whereas in some other cases some bolder reforms had to be embarked on. We are applying our own rules of reviewing our framework every two years, refining it when and where needed.
All those measures will be implemented only as of 1 February 2009, and so we trust that we have given an adequate time frame for all our counterparties to prepare for these refined rules. As a result of the new haircuts for unsecured bank bonds and ABSs, we expect that some counterparties will need to bring forward collateral in addition to the amount currently deposited with the Eurosystem in order to maintain their current levels of over-collateralisation. However, we consider that the overall impact on the availability of collateral will not impair the ability of banks to participate in the Eurosystem credit operations. So we see that this refinement will, again, not impair the ability of the banks to participate in our operations. This was what I wanted to tell you as regards the biennial review of he risk control measures.
I will also tell you that we took other decisions during this Governing Council meeting. We have decided today to renew the outstanding six-month SLTRO expiring in October 2008, at an unchanged amount of €25 billion and with maturity date on 9 April next year. We have also decided to renew the two three-month outstanding SLTROs expiring in November and December 2008 at unchanged amounts of €50 billion and with maturity dates on 12 February and 12 March 2009 respectively. On that too you will have a press release immediately. So you will have a press release on the staff projections, a press release on our decisions on the collateral framework and a press release on this renewal of operations, three months and six months.
Question: Firstly, by way of illustration, how much of the eligible collateral will be affected by these increased haircuts and add-ons? Just some idea, I mean, how radical a change is this going to be?
Second, just on the motivation, is it just about insuring the risk profile of your operations, or is it also about getting markets working again?
Trichet: First of all, as I said, we don’t think that it would hamper the way the system is functioning and impair the capacity of the banks to participate in our operations. I prefer not to give you any figures, but it is, as indicated, a small fraction of the present total amount of collateral.
Again, I prefer to utilise the term “refining”; we are refining our collateral framework. We did that with a view to optimising our risk control. The motivation can be, as a by-product, that we will have a positive impact that will help the market to be more active. But I would say that we have been reasoning very much on the basis of our risk control and with a view to optimising our own risk control. But I don’t exclude of course the by-product that I just mentioned.
Question: Could you just then update us on what is the level of ABSs as a percentage of collateral currently deposited with the ECB?
Trichet: I don’t have the figure here. I prefer not to give you a figure which would be challenged, but this can be checked very easily…..
Question: Do you have a target to bring it down? Is there a particular level which you would be comfortable with?
Trichet: No, we have no target to bring it down at this stage. As I said, we maintain the eligibility of the various categories of collateral. We only want to be sure that we are optimising the risk management of this collateral.
Question: Just a quick question on the ratings agencies. You said you want to improve the disclosures of the ratings agencies on the various ABSs that are being submitted. At the moment the ECB – if I get this correct – is happy with just one rating from one ratings agency. Are you changing that so that eligible collateral will have to be rated by two agencies?
Trichet: No, what I said was that we wanted that it would be absolutely clear that we would have a comprehensive analysis of the structural and the legal aspects of the ABS in question, of the assets that are backing that security, a detailed assessment of the collateral pool, and that we wanted this assessment to be repeated on a quarterly basis. I have nothing else to say at this stage.
Question: You mentioned some add-ons, additional haircuts on the ABSs. So far, if I understand correctly, the top-level haircut was 18%. Is that ceiling still valid?
My second question: we all know more or less that there has been some anecdotal evidence that apparently there has been a change in the use of collateral, in part in some countries with problems in the mortgage markets, which apply to the ABSs of course. But what is new to me is that there have been problems with unsecured bank bonds, which I think is a tradition of Germany but I’m not sure. What is the deeper reason for this, for the change in the haircut on the bank bonds?
Trichet: First of all, as regards the 18% so far has been applied to a certain category of ABS. The 12% is now the level of haircut that we apply across the board, as I already said. The 5% valuation markdown is on top of that for those particular ABSs that are theoretically valued, which is cumulative with the 12% or any other haircut.
As regards the bank bonds, we judged that it was appropriate to introduce this haircut of 5% on unsecured bank bonds. I have no other explanation. It’s true that we have observed an increase in the use of unsecured bank bonds, and we consider that they remain eligible, but we have introduced this element of haircut.
Question: When we were talking about the financial crisis a year ago, there was by many institutions – also by the central banks – a feeling that it might be a temporary matter, a few months down the road we might be over it. To what extent did you observe in the money markets, also with regard to your refining of collateral requirements, a fact that financial institutions were leaning more and more on the central bank funds as almost a secondary market, as interest rate arbitrage etc., and by that same token almost not even bothering to get a functioning money market going themselves any more?
Trichet: First of all, we were not an institution that considered that what we had been observing since 9 August 2007 was a very temporary short-term episode. We took it seriously from the very first day, as you know, and our judgement appeared to be right in this respect, i.e. that it was a very serious and very significant market correction that could last. It has lasted, you are absolutely right. Again, I’m happy that our collateral framework appeared to be adapted to new circumstances that were extraordinarily demanding for all of us, and this was absolutely clear across the Atlantic, across the Channel. We see tensions continuing, that’s clear enough. Particularly when you look at the differential between the three-month deposits and the overnight swap interest rates, you clearly see that we still have an anomaly at least in comparison with what was the case in major markets before the start of the turbulence. So we have all the elements to characterise something which is very lasting. That being said, we also have to work for, in particular as regards the functioning of markets, a more normal functioning of markets. It is the efforts that are being made by colleagues everywhere in the world, particularly in the industrialised world. We are cooperating very closely as you know. I didn’t announce anything on our cooperation across the Atlantic with the Fed, but you know that we have a very close cooperation with the Federal Reserve as regards precisely this refinancing in dollars. And I would say that we will continue in the central bank constituency to be very close to the market, monitoring the market and trying to help in any respect, because the ultimate goal is to return to a more normal functioning. But again, at this stage we have to take into account the fact that we still have to be very alert. It is no time for complacency in any respect, as you know.
Question: I’d like to follow up on my colleague’s question and on something you said. So you’ve said that these operations are designed to refine the central bank’s own risk profile and not primarily aimed at easing any market logjams or bringing a market back to more normal functioning. Given the way the ECB framework works, then, I’m tempted to say that this means that the ECB sees that the risk of default has in fact increased. Is that right?
Trichet: No, I would say that we have a biennial review and that we have considered since the very beginning of the turbulence that we have no reason to change our framework, so we did not. Had we reasoned as you suggest, then we would have immediately said we are in a period of turbulence, all risks are augmenting, we have to change immediately. It’s not at all what we did. So we continued to operate as we had in the past. We have a review. We considered that we were in our sentiment in the Governing Council not exactly at the optimum with the system which was set up two years ago, long before the start of the turbulence. And that’s the reason why we have taken the decisions I just mentioned and that you will have in more detail in the press communiqué immediately after the press conference.