We noted that the information which has become available in recent months indicates that the economic recovery in the euro area has maintained its momentum and should remain firm in the coming quarters. We have also witnessed somewhat higher inflation rates, mainly due to developments in oil prices. At present, our judgement is that although some upside risks to price stability exist, the overall prospects remain in line with price stability over the medium term. Accordingly, we have retained our monetary policy stance and left the key ECB interest rates unchanged. The level of interest rates is very low by historical standards, both in nominal and in real terms, lending support to economic activity. We will remain vigilant with regard to all developments which could imply risks to price stability over the medium term.
I shall now explain our assessment in more detail, turning first to the economic analysis.
The latest data releases confirm that the economic recovery in the euro area is continuing. According to Eurostat 's flash estimate, real GDP grew by 0.5% quarter on quarter in the second quarter of this year, having recorded a 0.6% increase in the first quarter. These growth rates are the strongest in the euro area for some time. The latest indicators of output and demand remain consistent with ongoing growth in real activity, increasingly supported by domestic demand, also in the third quarter of 2004.
Looking ahead, the conditions for a continuation of the recovery remain in place. Economic growth outside the euro area continues to be robust overall, even if subject to temporary fluctuations, and should continue to support euro area export growth. On the domestic side, investment should benefit from the positive global environment and the very favourable financing conditions. Improvements in corporate efficiency and higher profits are also supporting business investment. Moreover, private consumption should continue its gradual recovery, broadly in line with growth in real disposable income which, with the usual lag, should be further underpinned by an increase in employment growth later on.
Against this background, we expect the economic recovery in the euro area to continue and to become more broadly based over the coming quarters, leading to a somewhat stronger upswing in the course of 2005. This is also reflected in the ECB staff projections, which will be published today. They envisage euro area real GDP growth of between 1.6% and 2.2% on average in 2004, rising to between 1.8% and 2.8% in 2005. These growth rates are close to estimates for long-run potential growth and, for both years, they are slightly higher than was expected in the June Eurosystem staff projections. Available forecasts from international organisations and other sources convey a broadly similar picture.
Overall, the risks to these projections seem to be broadly balanced. On the upside, the ongoing momentum of the recovery may again imply more positive developments for economic growth in the coming quarters. On the downside, there are still concerns about continuing economic imbalances in other parts of the world. These imbalances could affect the sustainability of the economic recovery.
Another downside risk to the growth projections relates to oil prices. If these were to remain higher than currently expected by markets, this could dampen both foreign and domestic demand. In assessing these risks, however, it should be taken into account that, when expressed in euro, the recent rise in oil prices has been significantly smaller than in previous episodes when oil price increases had a major impact on the world economy. In addition, in real terms, oil prices are significantly below the peaks they have reached in the past. Moreover, when compared with the 1970s and 1980s, the oil intensity of production in the euro area and elsewhere has fallen significantly. Finally, it should be kept in mind that, in contrast to previous periods of oil price turmoil, this year 's rise in oil prices is not only due to supply-side factors, but is also driven by the strong global expansion. All these factors put the downside risks to economic activity coming from oil prices into perspective.
However, recent oil price developments have had a visible direct impact on price developments in the euro area. Eurostat 's flash estimate for annual HICP inflation in August was 2.3%, unchanged from July On the basis of current market expectations for oil prices, it appears unlikely that annual inflation rates will return to levels below 2% in the remainder of this year.
Looking ahead, however, there are no indications at present of stronger underlying inflationary pressures building up domestically. Recent wage developments have been moderate, and this trend is expected to continue for some time to come in view of the continued high level of unemployment in the euro area. If this is the case, and provided that one-off shocks to prices from other sources such as those seen in 2004 are not repeated, annual inflation rates should drop below 2% in 2005.
Against this background the ECB staff projections put average annual HICP inflation at between 2.1% and 2.3% for 2004 and between 1.3% and 2.3% for 2005. The lower end of these ranges is slightly higher than what was projected in June for both 2004 and 2005. The ECB staff projections for inflation are broadly consistent with other recently released forecasts.
However, several upward risks to the projections for inflation exist. Concerns relate in particular to oil price developments, which may continue to have a visible impact on inflation. Oil price rises also imply the risk of second-round effects emerging in wage and price-setting, a risk which intensifies when the economic upswing strengthens. A further upward risk relates to the future evolution of indirect taxes and administered prices. Indeed, upside risks to inflation are also reflected in the continued elevated levels of measures of long-term inflation expectations derived from financial market indicators. While these indicators should always be interpreted with caution, their current level calls for particular vigilance.
Turning to the monetary analysis, the annual rate of M3 growth has moderated significantly since the summer of 2003. This moderation largely represents a normalisation of portfolio allocation behaviour following the easing of the exceptional economic and financial uncertainty which prevailed between 2001 and early 2003.
Nonetheless, M3 growth remains resilient. It appears that the reversal of past portfolio shifts is proceeding more slowly than would have been expected on the basis of historical regularities. This may reflect an increased risk aversion of households and firms, given the stock market losses they experienced between 2000 and the spring of 2003. In addition, the low level of interest rates continues to support monetary expansion, especially of the most liquid assets included in the narrow aggregate M1.
The low level of interest rates also seems to be fuelling the growth of loans to the private sector, which has risen to a relatively robust rate over recent months. In this respect, the growth rate of mortgage loans to households is rather high and is associated with fairly dynamic housing market developments and real estate prices in several euro area countries.
There remains substantially more liquidity in the euro area than is needed to finance non-inflationary growth. At present, it is not clear how this excess liquidity will be used in the future. If significant parts of these liquid holdings were to be transformed into transaction balances, particularly at a time when confidence and economic activity were strengthening, inflationary risks would rise. In addition, high excess liquidity and strong credit growth could become a source for strong asset price increases.
To sum up, while the economic analysis indicates that prospects are consistent with price stability being maintained over the medium term, a number of upside risks need to be carefully monitored. Cross-checking with the monetary analysis also supports the case for strong vigilance with regard to the materialisation of risks to price stability.
As regards fiscal policy, first data for 2004 indicate that most euro area countries are likely to miss the original budgetary targets set in their updated stability programmes. In some cases, countries seem to have based their programmes on overly optimistic assumptions for economic developments. In addition, some countries have been implementing fewer consolidation measures than originally planned. As a consequence, the aggregate fiscal balance for the euro area is not likely to improve in 2004. Progress in fiscal consolidation needs to be prioritised and should be part of a comprehensive and growth-friendly reform agenda.
The Governing Council remains convinced that there was and there is no need for changes to the text of the Treaty and of the Stability and Growth Pact. The Pact is an appropriate framework for dealing with countries ' fiscal developments on a level playing-field. At the same time, we consider that improvements could be introduced in the implementation of the Pact.
In line with the Broad Economic Policy Guidelines, macroeconomic policies need to be oriented towards growth and stability in the euro area. This also requires sustained efforts to increase the flexibility of labour and product markets in the euro area. In this respect, several governments in the euro area have taken courageous steps over recent months. It is important that the reform momentum is maintained, taking advantage of the economic recovery. This will not only increase overall economic efficiency and enhance longer-term growth prospects in the euro area, but will also strengthen the basis for a sustained economic upswing in the euro area.
Question: To what extent were you consulted by the Commission about their reform proposals for the Stability and Growth Pact? Did Mr Almunia discuss these with you today? And perhaps you can tell us also what the view of the Governing Council is of these proposals?
Trichet: Well, first of all, Commissioner Almunia gave us a number of indications of what is likely to be discussed tomorrow. If I understand well, it is tomorrow that the Commission will discuss and approve some guidelines and suggestions and proposals. As I said, our present position, which is only a preliminary, provisional position, because we are waiting for the official proposal of the Commission -- and for that of the Council, which will decide as a last resort -- is that our preliminary, provisional observations are fully in line with what we have said before. We take it that improvements in the implementation of the Stability and Growth Pact could be made. And on a number of points we feel that some improvements could really be effective: in particular, as regards the" preventive arm '' of the Pact, where we think that we could strengthen the incentives for compliance" in good times ''. One of the most frequent observations which is made about the Stability and Growth Pact is that we have problems in difficult times because the system is not, in its implementation of the preventive arm framework, sufficiently cautious when things are going well. We also think that the timetable for the monitoring process, again in the" preventive arm '', could be improved so that stability and convergence programmes and their assessment would better guide domestic budgetary processes. And we also think, again, provisionally, that taking into account the cycle and the structural aspects of the situation could be, in the preventive arm, an important improvement as regards the implementation of the Stability and Growth Pact. Having said all that, as regards the" corrective arm '', we would insist that we do not see -- and we trust that this is also a view shared by others -- a need to change the wording of the Pact, the text of the regulation. In particular, the 3% threshold, which is in the Treaty itself -- and nobody has asked for a change to the Treaty -- is to be observed in nominal terms and certainly not in structurally adjusted terms. That is, of course, important, and it is the position of the Governing Council at this stage. It is fully in line with what I have already said here. We are now awaiting the decision of the Commission. But for the moment our preliminary position is what I have said it is.
Question: I would like to ask you what made you so optimistic about the economic outlook and led you to raise slightly your forecasts. Was it more that the economic performance in the first quarter, and to some extent in some countries in the second quarter, was pretty good, especially given that maybe in the past few weeks we have seen some signs of a slowdown in the growth rates of the world economy? So, is it more something that has already happened that made you optimistic for the whole year or something that is still to come?
Trichet: Well, first of all I would make two remarks. One is that, as you know, there is a distinction between the Governing Council -- which takes the decision as regards monetary policy -- and the staff, whether it is the staff of the Eurosystem, as was the case last time, or the staff of the ECB, which is the case this time. So, it is really a projection made by the staff. And we look not only at that, but at all other information, in particular the information that you have been mentioning. Second remark: the changes are not very significant. It is clear, as I said, that the present summer projections are a little more favourable than was the case three months ago with the spring projections. That said, it is a slight change and that would certainly not lead me to say that we have dramatic and significant changes in these projections. It is only a little more favourable. It is so, after taking into account a great amount of input, including the fact that for this year, as you might remember, the first quarter was better than expected and the second quarter was, in some cases, also a little better. And so, fortunately, in the first six months of this year we had facts and figures that were better than previously expected. Incidentally, it gives the Governing Council of the ECB the impression that it was right to mention on the occasion of successive press conference that we trusted that we were observing a gradual recovery. But you might remember that this was more or less questioned by a number of observers, which would have recommended doing this and that on the basis of a judgement which was less optimistic. The fact is that we said at the time that our judgement was that we were witnessing a gradual recovery and all facts and figures thus far, including those I have just mentioned, have confirmed this. But again, to sum up, it is not a significant change. I would say that it roughly confirms what our previous judgement was and what our present judgement is on this gradual recovery which is gradually materialising.
Question: On the Stability and Growth Pact, is the Commission 's proposal, as you understand it, going to restore the Pact 's credibility? And the other question I have is whether all of the suggestions that the Commission is making are, in your opinion, actually improvements in implementation?
Trichet: Again, I must be clear on the fact that what I am mentioning are only provisional and preliminary observations. They are in line with what we had already said before the Commission envisaged making formal and official proposals and so I will not comment further on the Commission proposal while we do not have the official proposal of the Commission. So, the Governing Council will say what it has to say on the basis of the official position. I do n't want to predict what is likely or not likely to be decided tomorrow by the European Commission.
Question: My question concerns the ECB staff projections. If you were to summarise these, do you see a growing divergence in the growth rates and inflation rates in the member countries? And is n't that a problem for the real economy and a problem, not for the common monetary policy, but for the discussions with Mr Zalm, for example? If you can see that the inflation rate in the Netherlands and Finland is on the low side and the opposite in Greece or Ireland, is n't that a real problem for the real economy?
Trichet: This is a good question, and an important question. In all very large economies that I know -- and after all I know at least this one, the euro area, and another one which is approximately the same size -- in these kinds of continental, very large economies you have, and you might have, and we are observing, from time to time, substantial differences from country to country, from state to state, from, economy to economy, You might very well have a boom in one place while you have difficult periods in another, and I do n't want to cite any particular economy in Europe, but we all have in mind such examples. And it is true for growth, for the buoyancy of one economy whilst on the other hand, for the difficulties that one other economy has to cope with. It is also true for inflation, and academic research has suggested that, when you look at the overall level of inflation in our own economy and in the other big economy that I have mentioned, we see that the orders of magnitude of the overall dispersion of inflation from state to state could be considered very similar. There is no significant differential. So what we are observing, namely that there are indeed differences in economic behaviour and in inflation from country to country in our own continental economy in the euro area, is probably something natural in such a wide continental economy. And, as you know, the Governing Council of the ECB looks at the economy as a whole, the sum of all those individual economies, just as our friends at the Federal Reserve add together California and Massachusetts, even if they are not necessarily behaving in exactly the same way. And I would add that it is a requirement of the Treaty and that each of us -- not only, of course, the members of the Executive Board, but also the governors of the national central banks -- has to look at the situation from the point of view of the euro area as a whole and not from a particular national perspective. That being said, of course, I think it is important to understand why we are observing those differences and, of course, to do all that can be done -- both by the various interested parties and particularly, of course, the governments themselves and the parliaments and social partners -- to understand why we are observing certain things and why, perhaps, on a country-to-country basis, improvements would be appropriate. But again, let 's not forget that this is something which is normal in a big continent-wide economy with a single currency.
Question: Mr Trichet in July you said that the ECB had no bias. Do you have a bias now?
Trichet: I will repeat, and give you a sense of our understanding of the situation. We are confident, as I said, that we will go back to our definition of price stability next year on the basis of our present assumptions, i.e. that wages and salaries are moderate, that there are no second-round effects from the increases in the price of oil, that there are no nasty surprises regarding the price of oil in comparison with our assumptions, which are based, as you know, on futures markets, and that there are no bad surprises regarding indirect taxes and administrative taxes, which have been responsible, this year and in previous years, for some increases. Our diagnosis is that strong vigilance is of the essence in the present situation. Upside risks are present and visible. So we are confident, on the basis of our present assumptions, and vigilant, because it is something which is not only our duty but which stems from the present situation.
Trichet: And I would like to remind you of something which is extremely important in our eyes, which is that the present European economic recovery relies very much on a favourable financial environment. This favourable environment is characterised in particular by the level of medium and long-term market rates, which we do not command ourselves but which are determined by the market. And why do we have a very favourable financial environment? Because inflationary expectations, which are enshrined in these medium and long-term market rates, are in line with our definition of price stability. We look at that very carefully, and our surveys are fully in line with our definition of price stability. We are also observing what happens in the financial markets in this respect. Overall the present level of medium and long-term market interest rates is favourable again at the level of the euro area as a whole, owing to the fact that these inflationary expectations are favourable, in line with our definition. The reason for these favourable expectations is our own credibility. And this level of credibility is entirely dependent, in the eyes of all observers and, I trust, of yourselves and the market participants, on our vigilance.
Trichet: It is because there is a belief that we are vigilant and that we are credible that market expectations are as favourable as they are. This to explain why we believe that this strong vigilance is appropriate in the present circumstances and is helping to preserve this favourable environment and therefore growth.
Question: Mr Trichet, you seem to be quite happy about the decline in the growth rate of M3. But in two months the growth rate has increased again. What is the reason for that? That is the first question. Can you please explain the arguments you have put forward so far? And the second question: when does the Governing Council intend to approve the ESCB/CESR standards for the clearing and settlement industry?
Trichet: On the first point I am not sure that I was that happy. No. I mentioned that we had to look at it very carefully. I said that we undoubtedly had excess liquidity -- I do not want to paraphrase, or to read what I said again, but we really have to look carefully at M3 growth which remains resilient, as you have mentioned. It appears that the reversal of past portfolio shifts is proceeding more slowly -- and I trust that this is exactly your point -- than would have been expected on the basis of historical evidence. So, that is our analysis. We have to look at it carefully. We should not treat with benign neglect what we are observing in this respect. And I mention that explicitly. As regards the ESCB position and the CESR clearing and settlement issue I would not like to say anything on the timetable. We are thinking about it and I will let you know once we have reached a conclusion.
Question: Mr Trichet, I have two questions. The first question is: did you discuss all policy options in the Council today, including an interest rate cut? And my second question concerns excess liquidity. You explained that there might be a danger when the economy is picking up more strongly. Could you elaborate a little bit on this? Does this mean that there must be a stronger signal from private consumption, or stronger signals from the labour market?
Trichet: Well, on the first point, we did not discuss an interest rate cut. On the second point, if I have understood the question correctly, we have had a recovery that was triggered by exports, by net exports. It is our judgement that the recovery will progressively become more broadly based, namely that domestic consumption, on the one hand, and investment, on the other, will materialise and help -- I would say -- allow a broader base for the recovery. There are major differences from one economy to another. That could bring us back to an earlier question. But of course, I am speaking of the euro area as a whole. We have already observed -- as the figures which have been published show -- that there was a progressively more broadly based recovery, as is normal and as is to be expected. At the time when we had had the feeling that consumption, household consumption in particular, was very weak, abnormally weak, and that part of this weakness was due to, perhaps, the sentiment that inflation would hamper purchasing power in the household constituency in future, we had said to households that they could be confident, that we were there, that we were the guardian of the currency and that we would take care of this threat that some households perhaps felt looming. And I think that this helped. I do not want to overemphasise the messages we may send, but I feel that they were part of the overall confidence rebuilding. The fact that we are the guardian of the currency, and -- in some respects -- the guardian of the confidence, a kind of sanctuary for confidence, is, in our opinion, helping the various economic agents and constituencies in particular in the present conjuncture. It is also clear that an acceleration of investment should also be part of the broadly based recovery. And I would like to mention here that the favourable financial environment we currently enjoy is certainly regarded and understood by economic agents and investors as part of the recovery process.
Question: You said that you did not discuss a cut. Did you discuss a hike?
Trichet: I said that we did not discuss a cut, I said that we considered that what we had observed was in line with our definition of price stability. We maintain our rates as they are and we are pretty vigilant, because there are upside risks to price stability.
Question: Some economists believe that the peak in the economic recovery of the euro area has already been reached. Do you agree with this assumption?
Trichet: I have no response other than what has been indicated by the various projections that we have available -- not only the staff projections, which are published immediately after our meeting today, but I have mentioned the figures, and you can draw your own conclusions from those. The real GDP in 2004 in this forecast will be between 1.6% and 2.2%, and between 1.8% and 2.8% in 2005. So I would not say that this signals that the peak is in 2004 because the ranges are superior in 2005 to what we have observed in 2004. So, what we publish does not confirm your assumptions.
Question: To come back to the Stability and Growth Pact: you make a very clear distinction between changes to the Pact and changes in its implementation. Am I right in understanding that you see the debate and the changes being proposed or that will be proposed tomorrow by the Commission as merely concerning the implementation and are therefore to be welcomed because they relate to improvements, or do you fear that there may be changes that are fundamental to the Pact itself and are therefore facing its credibility?
Trichet: Well, again, we will see. It is a very peculiar situation because the Commission will examine these proposals tomorrow and I do not want to prejudge anything. I would say that if the Commission decides to propose a number of improvements to the implementation, then that would be in line with what we have already said and we would, of course, welcome them, provided we look at them very carefully. Again, as I said, these are preliminary observations and we have to be very precise, very professional in such matters, which are highly technical. If there is a proposal to change the rules and to change the text, i.e. the wording of the Pact, then it is clear that this would not be at all in line with our own recommendation.
Question: You have already estimated that, based on current market expectations for the price of oil, it is likely that you will miss your inflation target for this year. Business and consumer sentiment has already been hit, to a certain extent, by fears over lingering and ongoing robustness in oil price developments over the last nine to twelve months. And projections actually, made by many market observers, participants, including the banks, earlier this year stated that the average price of oil would be significantly lower than it currently is. Is it possible that you, as well as a number of other market participants and observers, have perhaps underestimated the risks -- or even dangers, inflationary dangers -- of a sustained oil price robustness.
Trichet: That is a very important question. Again, we undoubtedly have to take into account these events, which nobody was able to foresee, if you look at previous assumptions. And we also have to recognise that it is very difficult to foresee such an evolution. Futures markets, for instance, have thus far been wrong in pre-assessing or guiding the projection for future price levels. That said, I do not know of any much better methodology than to look at the futures market in this respect. That notwithstanding, we also have to take into account, as I said earlier, that energy intensity has improved in all economies, also in our own economy. And in our own economy, if I compare the current situation with the situation in 1973-74, the first oil price shock, I would say that the energy intensity of GDP output has been halved. If I pick out oil consumption from among the types of energy consumption, it too has diminished quite substantially. The figures I have -- again, this needs to be checked very carefully -- but the figures I have would seem to indicate a reduction from 59% in 1971 to 42% in 2000. So we have a combination of a reduction of energy consumption per unit of GDP output and a diminishing share of oil consumption in total energy consumption. These are phenomena that we have to bear in mind when assessing the current situation. We, of course, also have the past appreciation of the euro, which -- as I have also mentioned -- has probably contributed to the fact that the impact may have been smaller than it would otherwise have been. All that having been said, it needs to be mentioned that this explains partially why, despite the importance of the oil price increases, we are observing projections that do not indicate a dramatic impact. What I have said on this impact seems to be true for the euro area economy. I do not want to qualify the situation in other parts of the world, but it also seems to be reasonably true for other major economies in the world, notably for the sister economy I have mentioned. But, we again have to be very cautious. I was cautious, I am cautious because we have risks that have to be considered, both for growth and for inflation. We have to remain vigilant, and I have explained why strong vigilance was of the essence today. That having been said, we are confident on the basis of our current analysis and trust that, thanks to our vigilance, price developments will be in line with our definition of price stability.