Persistently high and rising oil prices have had a visible direct impact on consumer prices this year, and inflation is likely to remain significantly above 2% in the coming months. This is a worrisome development, but there is no strong indication as yet that medium-term inflationary pressures are building up in the euro area. In particular, wage growth appears to remain limited, in the context of ongoing moderate real GDP growth and weak labour markets. Against this background, we have decided to leave the key ECB interest rates unchanged at their present levels, which are very low by historical standards. However, there are upside risks to price stability over the medium term. Strong vigilance is therefore warranted with regard to all developments which could increase such risks.
I shall now explain our assessment in more detail, turning first to the economic analysis. The economic recovery started in the second half of 2003, and we saw positive developments in the first half of 2004. Although short-term indicators have become more mixed, the basic determinants of economic activity remain consistent with continuing economic growth in 2005. On the external side, we see some moderation taking place following a period in which the world economy has experienced its strongest dynamism in many years. Nevertheless, euro area exports should continue to benefit from positive global demand conditions in 2005. On the domestic side, investment should be supported by the global environment, the very favourable financing conditions in the euro area, improved earnings and greater corporate efficiency gained through business restructuring. Furthermore, scope exists in the euro area as a whole for private consumption to strengthen, particularly once labour market prospects improve more visibly.
However, this outlook is surrounded by continuing uncertainty, in particular stemming from recent developments in oil markets. On the one hand, the magnitude and nature of this shock differ from earlier experiences, when oil price rises were much stronger and mainly due to supply constraints. In addition, the oil intensity of production is significantly lower in the euro area. On the other hand, recent oil price increases constitute a nonetheless sizeable adverse shock to the euro area economy. If oil prices were to remain at current levels, or even increase further, they would dampen the strength of the recovery both inside and outside the euro area. Under certain conditions, a smoother absorption of the oil price shock can be ensured: in particular, second-round effects in wage and price-setting must continue to be avoided, and fiscal authorities should refrain from taking measures which would prolong the necessary adjustment process.
With regard to consumer prices, annual inflation increased to 2.5% in October, according to Eurostat 's flash estimate. This was a strong increase, after the decline to 2.1% in September from 2.3% in August, and shows that oil price developments have had a sizeable direct impact on the euro area HICP in recent weeks. Moreover, the oil price shock may feed through the economy and generate further indirect effects, as indicated by developments in producer prices.
Looking further ahead, however, the information available so far does not suggest that stronger underlying inflationary pressures are building up in the euro area. Wage increases have remained limited since the last quarter of 2003, and this trend is expected to persist in the context of ongoing moderate growth and weak labour markets.
Nevertheless, a number of upward risks to the outlook for price stability have emerged over recent months. Risks are mainly associated with oil price developments, possible renewed increases in indirect taxes and administrative prices, and potential second-round effects stemming from wage and price-setting behaviour.
Further indications for the medium-term outlook are provided by the monetary analysis. The downward trend in annual M3 growth in the first half of this year appears to have come to a halt in recent months. The shorter-term dynamics of M3 have strengthened and its annual growth rates are rising. These developments reflect the stimulative effect of the historically low level of interest rates in the euro area on monetary expansion. Demand for the most liquid components of M3 contained in the narrow aggregate M1 is particularly strong. The low level of interest rates is also fuelling private sector demand for credit. In particular, the growth rate of loans for house purchase continues to rise and is now approaching double digits. Yet loan demand is becoming more broadly based, and the annual growth of loans to non-financial corporations is also picking up.
Given the continued strength of M3 growth over the past few years, there remains substantially more liquidity in the euro area than is needed to finance non-inflationary growth. This could pose inflationary risks in the future if the excess liquidity is not progressively reduced as a result of reverse portfolio shifts. Moreover, persistently high excess liquidity and strong credit growth could become a source of unsustainable asset price increases, particularly in property markets.
To sum up, the economic analysis suggests that underlying inflationary pressures are still contained, but a number of medium-term upside risks to price stability need to be monitored closely. It is particularly important that these do not affect long-term inflation expectations. Cross-checking with the monetary analysis continues to support the case for strong vigilance with regard to the materialisation of risks to price stability.
I would now like to make a few remarks on fiscal policies. Most countries have presented their budget plans for 2005. In some cases there are encouraging signs that Member States are planning to correct excessive deficits or make progress towards close-to-balance or in-surplus budgetary positions. However, there are other cases where there are significant risks that commitments under the Stability and Growth Pact will not be met, or where imbalances are on the rise and new breaches of the 3% reference value might occur. It is therefore imperative that 2005 budgets prioritise consolidation where this is necessary. Moreover, it is of vital importance that the reliable compilation and timely reporting of government finance statistics are ensured. Appropriate budgetary targets and compliance with fiscal commitments and reporting requirements will help to build confidence, support the economic upswing and prepare for the impact of population ageing.
As regards the European fiscal framework, the Governing Council remains convinced that improvements in the implementation of the Stability and Growth Pact are possible and would be beneficial. In this regard, the European Commission 's proposals for improving the implementation of the preventive arm of the Pact are useful. At the same time, the Governing Council warns against changes to the Pact and, in particular, the excessive deficit procedure. It considers the credibility of the 3% deficit limit essential to anchoring expectations of fiscal discipline. Moreover, strict surveillance and effective peer pressure on national budget policies are indispensable to preserving sound fiscal policies.
Finally, I would also like to take this opportunity to reiterate the need for progress on structural reform. Fiscal consolidation plans should be part of a structural reform agenda that favours growth, competitiveness and employment. As regards labour and product markets, the mid-term review of the Lisbon agenda -- now being prepared for the European Council meeting in March 2005 -- is a major opportunity to increase momentum in these fields. Structural reforms are crucial to a better performing EU economy, i.e. an economy with higher potential growth, more employment opportunities and greater resilience to shocks. Efforts to accelerate key economic reforms are now more important than ever.
Question: Two questions. Inflation now being worrisome, how fair would it be for us to write in our articles tomorrow that the ECB now has a bias? And the second question I have is on the euro. Earlier this year when the euro was at the same levels, you described the moves as brutal. What do you say today?
Trichet: My colleagues and I discussed that first question a lot today. Each of us participated in the discussion and we weighed up the balance of risks to price stability. You know that the needle of our compass is price stability. And we incorporate absolutely all elements, including, of course, our judgement on the strength of the economy as regards its impact on this needle of the compass of price stability. We had a lot of views. The weight of the upward risks to price stability was assessed. It is clear that we see these upside risks to price stability augmenting. That is absolutely clear. And it is the reason why we consider the posture of strong vigilance to be the appropriate posture, strong vigilance to clearly communicate to all economic agents that we will not let secondary effects materialise. We are there to ensure that there are no secondary effects. And that is the message of today 's Governing Council.
Trichet: On the exchange rates I would only say that we all signed the Washington communiqué: the Secretary of the US Treasury and the President of the Federal Reserve System, as well as European counterparts, including myself. It captures the present sentiment of the G7 community. Thus we all signed, and I signed in particular, the sentence stating that" excess volatility and disorderly movements in exchange rates are undesirable for economic growth ''. I would also mention that I read with great interest the reiteration a few days ago by the Secretary of the US Treasury that the policy of the United States in this respect remains the policy of a strong dollar.
Question: I am sorry if I insist on the euro. In Basel in January you said you were worried. Now that oil prices are going up so much, people say in the market that you are happy about the euro rising so much. I mean not for the growth but because it dampens the oil height. Is that correct?
Trichet: Almost one year ago I said that excess volatility and disorderly movements on exchange markets were undesirable. That was then captured in the Boca Raton communiqué and in the following G7 communiqué of Washington that I was just quoting in response to the previous question. But there is a continuity in this sentiment.
Question: Does it dampen oil prices?
Trichet: I told you that I stick to what I said on excess volatility. This is a continuous position, a long-standing position.
Question: I have two questions. First, is it correct that you now expect the inflation rate to be on average slightly over 2% next year and that it will then go down under 2% in the following year, that is, in 2006? Second, is it correct that you now see slightly greater downside risks for growth than upside risks?
Trichet: In reply to your first question, we will publish our new projections as you know in a month 's time and then you will know what the new staff projections are. At the present time, I would say that what is clear to me is that the present pick-up of the CPI which we are observing will continue for some months and will perhaps even increase. So I warn you that there is the likelihood, as far as we understand the consequences and, I would say, the passing-through of the oil price impact that we will probably see. So that is very clear and I warn you in advance. Then, it will continue for some months next year and then we think that at a certain moment we will go back down to our definition of price stability. The passing-through of this oil shock will take place over time, but of course will not be permanent. I remain very prudent and cautious and I will not respond to the question on the average of next year. It depends so much on the oil price itself and what is likely or unlikely to happen and I do n't want to make any projections. The working assumption when I was mentioning the profile that I had in mind is that the price of oil would remain at the same level. You know that in the same G7 meeting that I was mentioning, we also called for appropriate conditions for a decrease in the price of oil and it is our sentiment that the present level is not in line with what would be advisable in all respects. So we will see what happens, but we strive to get a more appropriate -- I would say -- supply and demand" encounter '' in order to have prices that would be lower and more in line with what is desirable for the global economy.
Trichet: In reply to your second question, it is absolutely clear that under a working assumption that the price of oil remains at the present level and may even rise further, which is a possibility that we hate but that we have mentioned, clearly the impact on inflation is upward and the impact on growth is downward. So under this assumption it is absolutely clear that downward risks for growth are there and are rising. That is absolutely clear and I would say that in some respects it is an arithmetic consequence of the transfer of revenue associated with the pick-up in the price of oil from oil-consuming economies to oil-producing economies. That is absolutely clear.
Question: Mr Trichet, to come back to the euro again. The euro is stronger than it was just a few weeks ago. I was wondering if you were concerned going into next year with slowing growth and about the effect of the stronger euro on euro area exports. Also, you mentioned in your speech today that liquidity in the euro area had fuelled demand for house loans. I wanted to ask if you see any potential bubbles in any markets in the euro area and what the appropriate monetary response to that might be?
Trichet: On the first question, I am very clear and I do n't want to repeat again the fact that excessive volatility and disorderly moves in the exchange markets are undesirable. I said that and I repeat that and I say it so clearly that I take it that there is no need to repeat it again.
Trichet: On house loans, we have mentioned in a number of recent meetings of the Governing Council that when we analyse the counterparts of M3, we see credit to the economy which is quite dynamic. Within this, credit to households is pretty dynamic and is now close to two-digit figures. It is also clear that we are observing in certain economies, not in all economies and certainly not in our economy as a whole, a phenomenon of asset inflation in the real estate sector which has to be examined very carefully. But again it is not a phenomenon that we are observing in the euro area as a whole, only in a number of economies.
Question: Mr Trichet, I do n't see any reference in this statement, direct or otherwise, to the problems or the concerns about the twin deficits in other regions of the world, particularly the United States. Given that we have just had an election and the current administration will continue, does this mean by omission that there is not an immediate concern about the twin deficits? Clearly this would have an impact on the euro, with the reduction of deficits having a significant impact on the dollar in terms of weakness and of course the corresponding effect on the euro.
Trichet: On the dollar I already said what I had to say if you permit me. On the twin deficits it 's absolutely clear that the unanimous sentiment of the Governing Council is that we have a lack of savings in the US. We do n't disagree with the US on that. As you know, it is a joint diagnosis which is made by both our US friends and ourselves that there is a lack of savings in the US. The correction of this lack of savings is, I would say, the" homework '' of the US, while we have our own homework, which is structural reforms and making our economy more flexible and more resilient. On both sides of the Atlantic we have assets and liabilities and we all agree on these: our own assets are that we are balanced and we are financing our own investment with our own savings, while the US is not ; by contrast, the assets of the US are that they have a very flexible and a very resilient economy and I would say they are permanently proving that in the present conditions of the global economy. So, all that being said, in our own analysis it is very important that the US progressively, but I also would say efficiently and effectively, correct this lack of savings, which would of course reduce the domestic and external imbalances per se. We agree on that, the problem is the delivery on both sides of the Atlantic.
Question: Mr President, could you help us to judge the latest movements of the Bank of China in the appropriate way? What is behind their moves and of all these verbal statements we are hearing about more flexibility. Is that Boca Raton showing finally in the right way?
Trichet: Well, I will certainly not interpret the position of the Chinese authorities. I would only say that one of the issues which is at stake in China, as far as I understand it, is the cooling down of some abnormally buoyant features in the economy. Until this most recent decision, most of the measures taken were administrative measures -- instructions or directions given to a variety of economic agents or banks -- and it is certainly appropriate that market economy weapons should be utilised to move towards increased control of the cycle in the Chinese economy, so the decision is certainly opportune from that point of view. I will not elaborate on whether or not it announces anything else, you might ask the Governor of the Bank of China and the Chinese authorities. I would only say and confirm that there is a consensus in the G7 communiqué to signal that some currencies -- not the particular currency that we are talking about here, i.e. the Chinese currency, but a number of currencies in Asia -- could certainly be allowed to appreciate, to some extent, by market forces, in a progressive, orderly and smooth fashion, which is not the case today. So, I am not saying anything that has not already been said in the Boca Raton communiqué and then in the two subsequent Washington communiqués.
Question: You talk about the pass-through of the oil price shock. So, as far as direct price effects go, that is clear to me. As far as the indirect price effects go, this is not clear to me. Could you explain that? You talk about the passing-through into the real economy of the price effects and then we have all this liquidity around. How does the ECB know about these indirect effects and if it is possible that these possible price increases -- you talk about price-setting behaviour -- will be withdrawn later on? Will they, or does n't the liquidity allow for that excessive price setting and you ca n't do anything about it?
Trichet: These questions are, of course, at the heart of our own diagnosis and understanding of what our duty is. It is absolutely clear -- as I said a moment ago -- that when you have an oil shock or when you have a commodity shock it has a direct impact -- an arithmetic, mathematical direct impact -- on growth, which is depressive, and on inflation, which pushes inflation up. The figures, the equations are there. Then, our duty is to ensure that there is no long-lasting effect on inflation. It is our duty ; we are there to ensure price stability ; we are there to deliver price stability ; we are there to permit all economic agents to make the working assumption that price stability will be delivered over time -- not just, as I used to say, on a two-year or a five-year basis, but on a ten-year or even a 30-year basis, because a number of Treasuries are issuing Treasury bonds on a 30-year basis. So, we have to deliver that and we have to take the measures that are appropriate for that and we have to be credible in delivering that price stability over time. So, the problem of the second-round effects is of course crucial. If you have no second-round effects, then you have the hump which goes with the effects of the price of oil, which materialises of course in the figures. But after a certain period of time it disappears and you are back to your definition of price stability. And that is the reason why I insist so much that what is decisive for us is the avoidance of second-round effects. And these second-round effects are multiple. You have, of course, the spiralling of wages and salaries. We have mentioned that this is very important, because of the subsequent impact on unit labour costs and on inflation. That is one of the key elements and is extremely important. Another element is, of course, inflationary expectations. If economic agents ' inflationary expectations are solidly anchored in line with our definition of price stability, there is no reason why, in the price-setting mechanisms -- the numerous price-setting mechanisms that you have in the market economy -- we should see a permanent increase in inflation. If you are not credible in delivering price stability and inflationary expectations increase, then you might see a generalisation of those second-round effects. That is the reason why we are communicating with regard to those second-round effects, why we say that, for us, they are crucial, and why we say that we are in a strong vigilance posture. We have to be ready to prevent these secondary effects, which would, of course, for all reasons be totally contrary to what we are required to deliver as a central bank, but which would also have a direct impact on the yield curve of the euro area and would immediately push up the medium and long-term market rates. The medium and long-term market rates would immediately incorporate the addition of basis points on top of the definition of price stability to incorporate the inflationary expectations, which would increase in the presence of second-round effects. So, it is very important, for all reasons, that we do not have second-round effects and that we maintain inflationary expectations in line with our definition of price stability.
Question: I would like to ask you about second-round effects. I read in a report that the ECB will have, or has had, a meeting with trade union leaders. Could you please comment on this? Is it helpful for you to have direct communication with the labour unions?
Trichet: We have regular meetings with trade unions at the European level. It is part of the European framework of communication. We can exchange views and we explain to them what we are doing -- exactly as we explain what we are doing to the European Parliament and, through you, to the full body of public opinion in Europe. And they explain to us how they see things. So, it is a very important way of communicating, and we are very keen on communicating. We also communicate with the social partners in general -- the entrepreneurs -- not only the unions as, in decentralised, market economies, the social partners play a very important role. Economic agents in general play -- on a decentralised basis -- a very important role.
Question: I have two questions. First, on second-round effects. In your statement you talk about wage rises being limited. I wondered if you could not, in fact, go a little bit further? The trend seen, for instance, in Germany at Volkswagen yesterday is very much for pay freezes. So, I wonder why you talk about wage rises being" limited ''. I think that, in the past, you and members of the Governing Council have said you have seen" no evidence of second-round effects ''. And the second question is on currency markets: I was just wondering if you could give us a definition of what you mean by" excessive volatility ''. Do you see something that is an immediate threat or is this something you fear might play out as these transatlantic adjustment purchases take place?
Trichet: On the second question I will be very clear: the terms" excessive volatility '' and" disorderly movements '' speak for themselves. And I say that again, one year ago I signed up to that, and I have repeated it again today very clearly. On the first question: the euro area economy comprises a number of economies, and what is observed in some economies is not necessarily in line with what we observe at the euro area level. Take the German economy, for instance, which is a very important economy in the euro area. Until now we have observed unit labour costs and nominal increases in wages and salaries that were very moderate. These developments were in line with the need for the German economy to catch up in terms of cost competitiveness and to take account of the fact that reunification has had a general impact on costs in Germany. So, in the case of Germany there is a special element of" slow motion '' with unit labour costs that is fully in line with what is necessary. For the rest of Europe and for Europe as a whole, we consider that it is extremely important to monitor what is happening in terms of wage developments and unit labour costs. We do not have the feeling that we are observing, very fortunately, at the present moment what I would call secondary effects -- those effects that we want to counter. But we have to remain vigilant. On top of that, I would say that we have to remain strongly vigilant, which is why we use the expression" strong vigilance ''.
Question: Mr Trichet, two questions. First: China has signalled today that a rate hike could be a first step to currency reform. How do you think this will affect the euro area? And second: have you already spoken to the US administration since the Presidential elections there?
Trichet: On the second question I would say that we are in constant contact with our friends across the Atlantic. I have not had contact since the election. But that is only a question of hasard, this has just happened by chance, because we have contacts on a permanent basis. And we have a level of mutual confidence that -- I trust -- is very strong. On China I would say that what is good for the Chinese economy -- and I take it that these developments are good for the Chinese economy -- would certainly be good also for the global economy and for all economies in the world. We have a joint interest in both our economies for this to be managed as well as possible.
Question: You said before that high oil prices have a negative impact on inflation and on economic growth. Do you think that in the presence of high oil prices -- or even higher oil prices -- there is a risk of stagflation for the European economy?
Trichet: No, at this stage that is certainly not our analysis. First of all, because we are" there '' as regards inflation and, as I have already said, we are strongly vigilant and -- and this is a reason why we did not increase rates today -- we take it that the situation, the overall balance of risks to price stability, is such that we have the maintenance of price stability over time in hand. As regards the impact on growth: there is an impact on growth, as I mentioned in response to previous questions. But we would certainly confirm at the present moment and on the basis of all the information we have that, even if the impact is negative on growth, it is not driving us to a situation where we would be in stagnation. And our analysis is that we will continue to see growth close to our growth potential in the euro area as a whole. And that is not only our own analysis -- it is an analysis which is shared by all international observers and international institutions.
Question: Mr Trichet, you have just celebrated your first year at the ECB. So, what are your first impressions? Was the job harder than you thought? Easier?
Trichet: It is a job which is very, very impressive I have to say. It is not harder than I thought, but one discovers Europe and the world through a different angle. So, it is extraordinarily challenging. The Vice-President and I have the privilege to be the leaders of various teams, and the team spirit is very, very profound in central banking. We know that we have to have the same values, the same way of looking at all the challenges we face. So with the team which is the Executive Board, we have a particular responsibility to run this house, and also with the full body of this very, very impressive team, which is the Eurosystem. Delivering the currency for 306 million people, even more than in the United States, is quite a responsibility. And, since we have no role model, we do that in a way which has never been done before: with the ECB, the national central banks -- the full body of the team -- deciding on monetary policy here and then implementing it in the various economies. All this is extremely challenging. Also, the fact that we have more than 25 nationalities in this institution, where cross-fertilisation is of the essence, is something which is also very striking. This is history in the making: the fact that we are 12 countries today, but we know in advance that we will be many more tomorrow ; the fact that we started European integration with six but now are 25. The lesson I draw from all that is that history moves faster, much faster than we think. We negotiated and worded the Maastricht Treaty when we were 12. The idea that we would have to implement it with 25 or 28, or even more, was not at all in our minds. We underestimated the rapidity of the historical changes. And I know now that the worst thing to do is to underestimate the rapidity of historical changes. You are in an institution where history is in the making. And that is, of course, very, very impressive.
Question: Mr Trichet, two questions. First of all, there have been a number of governments in Europe, notably the German one, in the last few days that have considered a number of one-off measures designed to improve their fiscal position. On its face, there is an argument to be made here that they are avoiding dampening domestic demand at a time when it is somewhat fragile. I wanted to ask how you felt about these sorts of fiscal consolidation measures. And, just a follow up to the previous question, as far as your first year in office goes, how do you regard the European Central Bank 's success in building a truly European institution? Because, indeed, that is the challenge that you are alluding to in things like creating the staff, creating the mentality of thinking in the European sense versus in the national sense?
Trichet: On the one-off measures I would say that, as a general rule, we do not like one-off measures, because they are not recurrent by definition. And so, you might imagine that you have solved the problem for your first year, but then with your second, your third, your fourth, etc., you have the same problem without the means to solve it. Because the measure is a one-off and not recurrent. That being said, we respect the responsibility of each particular body, and we respect the decisions taken by Eurostat. There are a number of one-off measures that are rejected by Eurostat. For instance receipts from privatisation are not considered recurrent and are not, as you know, computed in the Maastricht deficit calculation. Other one-off measures, for reasons that are under the responsibility of Eurostat and the Commission, are considered legitimate. We do not want to challenge what they consider acceptable one-off measures even if we know, and we always make the point very clearly, that the fact that they are not recurrent creates a problem of continuity for the future years. This means that if you solve a problem with a one-off measure for year X, in year X +1 you have to solve the problem with a real measure, because you have to solve it on a recurrent basis. But again, we do not challenge what is considered legitimate according to the rules of Eurostat and the Commission.
Trichet: As regards whether or not the ECB is a truly European institution, I have a very, very profound sentiment that the ECB is a truly European institution. It has to be. We have a single currency. We do not have a multiple series of currencies. We have a single monetary policy. We are European by definition. I mentioned the team spirit. We have a very strong team spirit. We have the capacity to decide in real time. When we had the dramatic events of 9/11 in the United States, we were able that very afternoon to decide that we would pour extremely high levels of liquidity into the market in Europe to avoid a crisis. And we also decided to embark on a swap of 50 billion dollars with the Federal Reserve System in order to be able to deliver dollars in Europe to cope with possible problems of counterparties in New York. That was done in real time, on the very afternoon of the Twin Towers ' collapse. We are a totally operational institution, able to decide immediately, to take single decisions with all colleagues. And each member of the staff of the ECB reasons on the basis of the European interest. By definition, again, we have only European interests to defend. Each national central bank governor, when he enters the room of the Governing Council, has to reason on a European basis. The legitimacy of a member of the Governing Council, whether he or she is a member of the Executive Board or a national central bank governor, stems from putting him or herself at the level of the superior interest of the euro area as a whole, of its 306 million inhabitants. Of course, we have to improve on a day-to-day basis. We have to work out our corporate culture and improve all that we have been doing. But I really think we are a truly European institution.