Today the Governing Council decided to leave the key ECB interest rates unchanged. Following our regular economic and monetary analysis, we concluded that the current level of ECB interest rates remains appropriate, as the medium-term outlook for price stability continues to be favourable. The historically low interest rates are lending support to economic activity. The Governing Council will carefully monitor all factors that might affect this assessment.
I will now explain the considerations underlying our decision in more detail.
Starting with the economic analysis, recent data confirm that real economic activity in the euro area was very weak in the second quarter of 2003, with the Eurostat flash estimate suggesting zero quarterly real GDP growth. However, survey data -- which indicate that confidence is growing -- as well as recent financial market developments are in line with our main scenario of a gradual upturn in economic activity. In line with available forecasts and projections, we continue to expect this upturn to start in the second half of the year and then to strengthen further in the course of 2004. The factors supporting the expected pick-up in activity are both external and domestic. As regards external factors, recent data signal that a recovery is already underway in several parts of the world. This should lead to an increase in euro area export demand, counteracting the effects of the loss of price competitiveness. On the domestic side, ongoing adjustment efforts by companies to enhance competitiveness and profitability should improve the conditions for an economic upswing. In this environment, the low level of interest rates is strengthening incentives to invest. Furthermore, real disposable income in the euro area should be positively affected by terms-of-trade effects stemming from the past appreciation of the euro.
Downside risks to this main scenario for economic growth have declined over the past couple of months but have not disappeared. Macroeconomic imbalances in some regions of the world persist. Although these may not affect the short-term economic dynamics, they constitute risks over the longer run. In addition, high oil price levels may continue to have adverse effects on economic activity in the euro area.
As regards price developments, Eurostat 's flash estimate for annual HICP inflation in August was 2.1%. While recent oil price developments imply some short-term upward pressure on inflation rates, the broad picture of annual HICP inflation hovering around 2% during the remainder of this year remains unchanged. In 2004 annual inflation rates should fall below 2%, stabilising at levels consistent with price stability. This expectation is based on the assumption of moderate wage developments in the context of a gradual economic recovery. Moreover, the significant past strengthening of the external value of the euro should continue to have lagged effects which will limit upward pressure on prices, despite some recent corrections in the level of the euro exchange rate. Over longer time horizons, inflation expectations in the euro area seem to be well anchored at levels below but close to 2%.
Turning to the monetary analysis, monetary growth remained strong in recent months and there is significantly more liquidity available in the euro area than is needed to finance non-inflationary growth. In part, this is due to past portfolio shifts and possibly to an increase in monetary holdings related to precautionary motives. Moreover, the low level of interest rates has contributed to the high demand for liquid assets. The current level of interest rates is also counterbalancing the negative impact of subdued economic growth on credit demand. In fact, the growth of loans to the private sector has remained relatively robust since the beginning of the year.
At the current juncture, the ample liquidity is not expected to translate into inflationary pressure. However, monetary growth needs to be closely monitored as the significant amounts of excess liquidity could become a source of concern if they were to persist when economic activity strengthens significantly.
Summing up and cross-checking the information from the two pillars, our economic analysis confirms the expectation that price pressures will remain subdued in the coming years, in the context of a gradual economic recovery and moderate import price and wage developments. The strong monetary expansion should, in view of the economic situation, not be seen as adversely affecting this outlook for the time being. Overall, therefore, the medium-term outlook for price stability remains favourable.
The Governing Council took note with great concern of recent fiscal developments. In order to maintain the credibility of the institutional and economic underpinnings of EMU, it is fundamental to abide in all respects by the rules of the Stability and Growth Pact. As concerns the upcoming budget plans for 2004, a correction of excessive deficits within the agreed time frame is essential, with an annual structural consolidation effort of at least 0.5% of GDP for countries with fiscal imbalances. Fiscal plans need to be part of a comprehensive and credible medium-term strategy with emphasis on expenditure restraint and growth-oriented restructuring. Sound fiscal policies will help to boost investor and consumer confidence and enhance the prospects for stronger economic growth in the euro area.
Progress in implementing structural reforms is as important as fiscal prudence. Efforts to bring public pension systems onto a sustainable path and to further develop private pension schemes deserve support. At the same time, more reforms are needed to reduce structural rigidities in labour and goods markets. Such reforms are essential for addressing what is perceived to be the main economic problem of the euro area, namely the high level of structural unemployment.
Question: I would like to ask you: in June you gave us an inflation forecast for 2004 saying that inflation would average between 0.7 and 1.9% next year, and that forecast was based on the assumption of an exchange rate of 1.16 for the euro/dollar exchange rate. I think you are now in the process of looking at these forecasts to see whether they are still valid and I would like to ask you if - given the new exchange rate of the euro - if that forecast is still valid. And also I would like to ask you: you mentioned oil prices as one of the risks to the economic recovery. How strong a risk are they?
Papademos: Let me first say that in assessing the available information, and in the context of the economic analysis, we had at our disposal new ECB staff projections. These projections did take into account recent developments in all relevant variables, including the exchange rate. Now, as you know, we do not in the interim publish the results of these projections, but I can confirm that the expected inflation, both for the rest of this year, as well as in 2004 and 2005, is not fundamentally, is not essentially, affected by changes that have taken place in the exchange rate or in oil prices. And indeed, as I mentioned in the introductory statement, inflation is expected to be below 2% and in line with our objective of price stability.
Question: Mr. Papademos, some of your counterparts at the Fed have talked about a disconnect between its own views on the course of monetary policy and the views of the markets. I was wondering to what extent that might also be true for the ECB and euro markets?
Papademos: I am not sure that I understand exactly what kind of discord you are referring to between the ECB and the markets, but if you want to clarify this further, I can be more precise in answering.
Question: Basically, are you happy with the expectations of markets at the moment, the way they are pricing in no more cuts and future interest rate hikes early next year?
Papademos: Well, markets form their expectations on the basis of all the information available to them, including their own assessment about the likely stance of policies. I can repeat what I said earlier about our current assessment that the level of interest rates is appropriate, given the available information that we have and on the basis of the analysis we have carried out. And I do not believe it is wise to make unconditional statements about the future.
Question: Mr. Vice-President, if the recovery does materialise in the euro zone even more rapidly than is expected, should there be some new correcting actions in fiscal policy? And some more than 0.5 should be the target next year and could monetary policy give some backup to this fiscal policy?
Papademos: Monetary policy decisions, as I believe you very well know, are taken on the basis of a mandate and in order to attain the clearly stated objectives of monetary policy. In doing that, we take into account all information related not only to economic, financial and monetary developments, but also the policies, fiscal policies, that are being pursued. But there is no scope for any ex ante co-ordination, if I may call it that, of policies. We take interest rate decisions so as to achieve our objectives.
Question: Just noting the remarks you made at the end of your statement on the Stability Pact. To what extent do these continued breaches of the Pact make it harder for the ECB to contemplate future cuts in interest rates? And also, are you really saying here in your statement that the ECB has done enough now and it is really up to governments to do the rest to ensure economic recovery?
Papademos: Well, regarding the first part of the question, I think the answer I gave a moment ago is quite relevant, that fiscal developments and prospects -- by influencing various economic variables such as demand, prices and possibly interest rates -- are taken into account when formulating our decisions. As to the second part of your question, I think the introductory statement was very clear on that, but let me elaborate a bit on this. I think at present the fiscal problems faced by some countries in an environment of subdued economic growth have led some people to the conclusion that a relaxation of the rules of the Pact or a more flexible interpretation of the rules of the Pact would address short-term fiscal problems and the weakness of the economy. Now, we believe that these short-term considerations should not overshadow a number of other important facts and conclusions which are widely supported by evidence. And I think the first important conclusion is that sound public finances and sustainable public finances are conducive not only to price stability but also to long-term growth. Second, that fiscal consolidation strategies have often been accompanied by higher, rather than lower, growth. And third, and more directly related to your question, is that the extent to which an expansionary fiscal policy can influence, can have positive effects on growth, depends a lot on the overall fiscal position of a country, as well as on the extent to which it can strengthen consumer and investor confidence. Having said all this, having stated these conclusions, which I believe are strongly supported by the empirical evidence and experience, I think that we can add that in our view it will be conducive to growth to implement fiscal policies in the medium and long-term perspective and not in a way that may impair the credibility of the fiscal framework of EMU. To put it simply: the governments have certain tasks that they have to carry out.
Question: Mr. Papademos, how much does your positive outlook for the euro zone depend on strong recoveries in the United States and Japan? If those recoveries prove to be very weak, or very short-lived, would that significantly change your outlook for the euro zone?
Papademos: Yes. Of course the improvement in growth in the rest of the world, particularly in the United States, is an important external factor which underpins our projected recovery in the second part of this year, in 2004 and beyond. It follows that if the projected increase in growth is less than presently envisaged, there will be some negative effect on euro area economic activity. But at the same time I would like to point out that there are also domestic factors which in our view are underpinning the economic recovery. First, investment, which is expected to recover after a period of weakness, and at the same time consumption, as I noted earlier, positively influenced by terms of trade effects but also, in the coming years, by the projected further decline in inflation, which should boost disposable income. So our projection of an expected recovery depends on both external and domestic factors, but at the same time, as I acknowledged earlier, there are downside risks and some of the downside risks are related to the strength and the pace of the global recovery. Particularly in the United States and especially the recovery of economic growth in the United States.
Question: Mr. Vice-President, would you go so far as to say that at the moment the budget policies of the big EU states pose a bigger threat to the economy and the upswing than the economic surroundings and all the other factors? Is that the main concern that you have at the moment, the breaking up of the Stability Pact?
Papademos: It is an important factor, which adds to the uncertainty that exists and, depending on developments, it could either boost or undermine confidence, which is an important element in supporting the pick-up in economic activity that we are projecting at present.
Question: Could you address ECB 's staff projections for inflation. In June they had a medium rate for next year, which -- if I recall correctly -- was about 1.3%. Given the changes, particularly in the euro and oil, what is the revised projection? And also, could you tell us what the growth projection is for next year as well?
Papademos: Let me start with growth. I can say that for the year 2003, and taking into account developments during the first half of 2003, growth is expected to be somewhat below the middle range of the projections we published in June. However, for 2004 and 2005, the rate of growth expected now is virtually unchanged from the range projected in June. So, developments this year are influenced primarily by what has happened in the past. But there are, as I noted earlier, a number of encouraging signs and some data supporting the view that economic activity is picking up. And, looking forward, although we can conclude that growth in the present year will be, as I mentioned earlier, somewhat below that previously envisaged, it does not change essentially the projected growth for the coming years. And I believe that this is broadly in line with the forecasts and projections of other institutions and the private sector. Now, as far as inflation is concerned, the picture also stays essentially the same. Until the end of the year we expect inflation to hover close to or possibly slightly above 2%, in 2004 and 2005 to fall below 2%. And the differences between earlier and recent projections -- we take into account not only the change in oil prices you mentioned but also other relevant factors that influence the future evolution of prices -- are only slight.
Question: If you have not changed those forecasts it would then bring your inflation forecast below the level at which you have defined price stability. What messages will you then be sending with regard to the outlook for monetary policy?
Papademos: I think, as I mentioned in the beginning, I should repeat that. The projection implies that inflation will be below, but not far below, 2%. And as I said earlier, that is slightly different from our previous projection, slightly different but in the upward direction and by not much.
Question: Two questions. The first is a question on the monetary analysis. I can not follow this. The low level of interest rates has contributed to the high demand for liquid assets. This declaration has been the same for two or three months. Now we have a burst bond bubble in the last months. What is the conclusion of this correction of the bond markets? And the high liquidity: is this going to cause a new asset price bubble now? And the second question is: did Pedro Solbes, the EU Commissioner, join this meeting? What were his answers to your critics on fiscal policy?
Papademos: On your first question regarding the effects of the interest rates on money demand: the situation, really, has not changed in any fundamental way because the demand for broad money depends on the whole spectrum of interest rates. Short-term interest rates have remained unchanged. And the increase in long-term yields -- which by the way is a very recent one -- does not seem to have had any visible effects. The responses of investors and portfolio shifts are not immediate. They take some time. We could expect some reversal in the future, at least a partial reversal, of the portfolio shifts observed in the past from assets outside M3 into assets that are included in M3.
Papademos: On your question about Mr. Solbes: he attended today. And, well, I think he is very much in line with our views, and I would turn it around to say that the ECB has been supporting the position of the Commission, namely that it is essential for the credibility of EMU -- I would say not only the institutional, as we said in the note, but also the economic underpinnings of EMU -- that the Stability Pact is respected and the fiscal plans that have been adopted and announced by Member States with excessive deficits are implemented as initially envisaged.
Question: The Italian finance minister, Mr. Tremonti, presented a couple of months ago his plan for public expenditure in Brussels and he also explained it to the ECB. And today Handelsblatt, the German newspaper, wrote that Mr. Schröder and Mr. Chirac are also going to present such a European plan for public expenditure in order to boost economic growth. I would like to ask you if these plans first of all are consistent with the philosophy of the Stability and Growth Pact and what is your opinion about them?
Papademos: Well, in principle, the strengthening of infrastructure in the Union is, I would say, a generally desirable objective. And if done appropriately and financed appropriately, it could help to boost economic growth. However, the final assessment depends very much on how it is financed and on this I do not have, at present, detailed information in order to be able to give you a precise judgement. But it is crucial, of course, that the implementation of such plans does not impinge on and does not adversely affect the public finances of countries that are already facing serious fiscal constraints. So the short answer is: it depends.
Question: The OECD wants the ECB to keep the door open to further rate cuts. Mr. Welteke said this morning that the door should remain firmly shut. Do you think there is substance to the argument that a further rate cut could boost confidence and help secure what is a fragile recovery? And was there any discussion today about a rate cut?
Papademos: About rate cuts in the future, you mean? The answer is: no. And the answer to the question of whether there was any discussion about rate cuts in the coming months: every month, as you know, we assess all the information we have on the basis of the economic and monetary analysis, consistent with the monetary policy strategy. And the decisions that have been taken, that are taken every month, are based on such an analysis. And, as we meet every month, we reassess carefully and comprehensively the situation. Now, in the future, for the future, one can make -- and I am now talking in general -- hypotheses on the basis of assumptions. And these can lead to additional conclusions. So, alternative scenarios can be contemplated on the basis of alternative assumptions concerning the evolution of economic and monetary variables. But such an analysis does not lead to any conclusions for decisions at present. I would point to two statements in the Introductory Statement which suggest that, compared with two months ago -- so looking more to the past than to the future -- the risks to output growth are judged at present to be diminished but not to have disappeared. And there are, at the same time, positive upside risks -- particularly associated with positive economic developments and prospects globally. So, on the basis of all these developments, but also taking into account developments in other variables, such as the price of oil -- which is an important consideration -- the decisions will be made in the future.
Question: On 14 September 2003 Sweden is holding a referendum against or in favour of the euro. The polls predict quite a stable victory for the" no '' side. Do you have any comments on that?
Papademos: I believe I should not make any comment that could be interpreted in any way as influencing decisions. So I will make a general remark, which I believe to be appropriate and neutral. On the one hand, from the point of view of the ECB and the Eurosystem, we would be delighted if Sweden were to join the euro area. On the other hand, and this is the important part, this is a decision for the Swedish people to take. And whatever the outcome of this referendum, the ECB and the ESCB will continue their close co-operation with the central bank of Sweden, within the framework of the ESCB.
Question: Just a follow-up to the question of my Italian colleague. So you mean that a plan for infrastructure can boost growth, but it is better if it is mostly privately financed?
Papademos: I think you could infer this from what I said. I said, more precisely, that the outcome will depend on the modalities of the financing and whether it will impinge on public finances in countries that are at present facing fiscal problems. And if it does, it will obviously increase the pressures and the problems associated with the excessive deficits that have been recorded in these countries and will make it more difficult to implement budgetary policies and so to bring the fiscal position in these countries closer to balance over the medium term, which -- as we stressed in the Statement and as I stressed separately earlier -- we believe is going to contribute to rather than adversely affect economic growth.