Jean Claude-Trichet: Hearing at the Economic and Monetary Affairs
Committee of the European Parliament
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the
Economic and Monetary Affairs Committee of the European Parliament, Brussels,
19 December 2007.
* * *
Madame la Présidente, Mesdames et Messieurs les membres de la Commission
Economique et Monétaire, je me réjouis d'apparaître devant votre commission aujourd'hui.
Je commencerai mon intervention par une évaluation de la situation économique et
monétaire, en expliquant les raisons sous-jacentes à nos récentes décisions de taux.
Ensuite, je vous fournirai de plus amples informations sur les opérations de politique
monétaire de la BCE en réaction aux tensions enregistrées sur le marché monétaire ainsi
que sur la stabilité du système financier de la zone euro. Zum abschluss möchte ich ein paar
Anmerkungen zu den Auswirkungen der Globalisierung auf die Preisentwicklung sowie zu
Entwicklungen im Immobiliensektor machen.
Economic and monetary developments
Since my previous appearance before the European Parliament early October, incoming
information has fully confirmed our view that, in a context of vigorous money and credit
growth and sound economic fundamentals in the euro area, the risks to price stability over
the medium term are clearly on the upside, as I have said, on behalf of the Governing
Council, after our meeting on Thursday, 6 December. The recent substantial increase in oil
and food prices, together with unfavourable base effects from energy prices, owing to the
marked decline in oil prices a year ago, are having a strong upward impact on inflation in the
current context. Looking ahead, the inflation rate is expected to remain significantly above
2% in the near future, and it is likely to moderate only gradually in the course of 2008. Hence
the period of temporarily high inflation rates would be somewhat more protracted than
previously expected.
Looking further ahead, the December Eurosystem staff macroeconomic projections foresee
annual HICP inflation to be between 2.0% and 2.2% in 2007, to then rise to between 2.0%
and 3.0% in 2008, before moderating to a range of 1.2% and 2.4% in 2009. Compared with
the September staff projections, the ranges for 2007 and 2008 have shifted upwards. These
staff projections are based on two key assumptions. The first is that recent oil and food price
dynamics and their impact on HICP inflation will not have broadly-based second-round
effects on wage-setting behaviour. The second key assumption is that growth in profit
margins will moderate over the projection horizon. These two assumptions imply, in the
context of the staff projections, a continuation of overall contained domestic cost pressures,
which contributes to the moderation in inflation projected in 2009.
It is the view of the Governing Council that the risks to this medium-term outlook for price
developments are fully confirmed to lie on the upside, mainly relating to possible further rises
in oil and agricultural prices, increases in administered prices and indirect taxes beyond
those foreseen thus far. In addition, against the background of sound economic
fundamentals, stronger than currently expected wage dynamics may emerge, while an
increase in pricing power in market segments with low competition could materialise.
As regards economic activity, incoming information confirms the sustained nature of
economic expansion in the euro area, with real GDP growing by 0.7% quarter-on-quarter in
the third quarter, while indicating some moderation in the fourth quarter. Overall, the
economic fundamentals in the euro area remain sound. Looking ahead, Eurosystem staff
projects annual real GDP growth to lie between 2.4% to 2.8% in 2007, between 1.5% and
2.5% in 2008, and between 1.6% and 2.6% in 2009. In comparison with the September 2007
ECB staff projections, the range projected for real GDP growth in 2008 has been revised
slightly downwards, whereas for 2007 the new range lies within the upper part of the
previous one.
This scenario is based on the expectation that the global economy will remain resilient, with
the slowdown of economic growth in the United States partly offset by the continued strength
of emerging market economies. However, in view of the potential impact of ongoing financial
market volatility and re-pricing of risk on the real economy, this assessment remains
surrounded by a high level of uncertainty. And in the Governing Council's view, the risks
surrounding this outlook for economic growth lie on the downside.
The monetary analysis confirms the prevailing upside risks to price stability at medium to
longer-term horizons. On the basis of latest available data, covering the period to the end of
October, the underlying money and credit expansion remains vigourous, even taking
temporary factors into account, such as the flattening of the yield curve, the financial market
turmoil and specific transactions associated with the restructuring of certain banking groups.
Therefore, monetary and credit developments continue to require very careful monitoring, not
least with a view to better understand the response of the private sector to increased
financial market volatility.
Thus far, there has been little evidence that the financial market turbulence since early
August has strongly influenced the dynamics of broad money and credit aggregates. Indeed,
the expansion of loans to households and non-financial corporations has remained robust,
which may suggest that the supply of credit has not been impaired. To develop a more
complete view of the impact of financial market developments on bank balance sheets,
financing conditions and money and credit growth, further data and analysis will be required.
The ECB's Governing Council stands ready to counter upside risks to price stability, in line
with its mandate. Against this background, on 6 December we decided to leave the key ECB
interest rates unchanged. The Governing Council will monitor very closely all developments.
In particular, for the recent increase in inflation to remain temporary, it is essential that the
price and wage-setting behaviour remains unaffected by current inflation rates, so as to avoid
the emergence of second-round effects. By acting in a firm and timely manner on the basis of
its assessment, the Governing Council will ensure that such second-round effects and risks
to price stability over the medium term do not materialise. To firmly anchor inflation
expectations in line with price stability is even more important at times of financial market
volatility and increased uncertainty. In this respect, the Governing Council will continue to
pay great attention to financial market developments.
Monetary policy operations
Ladies and gentlemen, once the Governing Council has defined the monetary policy stance
necessary for maintaining price stability in the medium term, in line with its mandate as
defined by the Treaty, the ECB has the responsibility to also ensure the smooth functioning
of the segment of the money market that we influence. I should like to underline - once again
- that these two responsibilities are clearly distinct and should not be mixed.
Since we last met in October, tensions continued to be observed and during the last period
banks expressed concerns about their liquidity needs over the year-end. The new-year
period is traditionally a period of scarce liquidity, as market activity is subdued and banks are
preparing their year-end balance sheets.
In its open market operations, the ECB therefore pursued its endeavour to contribute to the
smooth functioning of the euro money market. In particular, we renewed our two
supplementary long-term refinancing operations and lengthened the maturity of the main
refinancing operation settling on 19 December from one to two weeks, thus facilitating the
coverage of the year-end liquidity needs of banks. For this specific operation, we announced
that we would satisfy all bids received at 4.21 percent or above, the 4.21 percent level being
the weighted average rate of the previous main refinancing operation one week before. This
announcement was consistent with our earlier communication and actions. It aims at
minimising the uncertainty banks face when bidding at this operation which is covering the
end of the year, and at keeping interest rates close to the ECB's minimum bid rate.
In the main refinancing operations since the beginning of August the ECB allotted
significantly larger amounts of liquidity than under normal circumstances with an aim to limit
the volatility of very short term rates around the ECB's minimum bid rate. These large
amounts of liquidity have always been absorbed later on during the maintenance period so
that the ECB has only provided banks with the liquidity needed for the fulfilment of their
reserve requirements on average over the maintenance periods. Let me also underline that
we only provide such operations against solid collateral, as always.
Overall, the ECB's actions permitted to maintain very short-term rates close to the ECB's
policy rate. The tensions, which are observed in the longer term money market rates are due
in particular to the persistence of uncertainties surrounding the financial health and liquidity
needs of financial institutions as well as the impact of the ongoing global financial market
correction, with a general re-appreciation of risks. Under these tense circumstances, let me
mention that, by reducing the volatility of the very short-term rates around the key policy rate
of the ECB and by containing pressures in the interbank term money market, the ECB's
monetary policy operations have contributed to a better resilience of the European financial
system without - of course - eliminating the causes of the tensions, originating outside the
money market.
During this period, the Eurosystem remained, as usual, in close contact with other major
central banks. In this context, on 12 December the ECB, the Federal Reserve, the Bank of
England, the Bank of Canada and the Swiss National Bank announced measures designed
to address elevated pressures in short-term funding markets. In particular, the ECB
participates in joint action with the Federal Reserve and the Swiss national Bank. The ECB
will offer up to a total of 20 billion US dollar in two auctions to Eurosystem counterparties
against ECB-eligible collateral.
Through its own actions as well as the joint efforts with other central banks, the Eurosystem
as well as the community of central banks have shown their capacity to cope with a number
of challenges that euro and global money markets are currently facing. More than ever, in
these periods of tensions, lucidity in the diagnosis, rapidity in the decision, and absence of
complacency are of the essence. This absence of complacency is particularly necessary as
regards financial stability.
Financial stability
I would now like to share with you our assessment of the financial stability situation, as
described in the recent Financial Stability Review. I will discuss briefly the role of financial
institutions and supervisory authorities in coping with the present financial market correction.
With financial systems undergoing a process of de-leveraging and re-intermediation,
uncertainty surrounding the financial stability outlook for the euro area has heightened and
may persist until it becomes clearer how the potential balance sheet effects of the turbulence
will be spread across individual financial institutions. Clarity is also needed concerning
liquidity commitments to off-balance sheet vehicles, and the magnitude of assets that may be
re-intermediated back onto the balance sheets of euro area financial institutions. The
process of improving clarity, which started when Q3 2007 financial statements became
available, will be advanced further when institutions publish their annual audited accounts for
2007 as a whole.
Given the uncertainties, the adjustment process in the financial system in the coming period
may be challenging, and we have to be prepared to the materialisation of risks at any time.
That being said, there are mitigating factors including a broadly favourable economic outlook,
the largely sound balance sheets of households and firms, and the generally sound capital
positions of core financial firms. This should not, however, provide any grounds for
complacency given the heightened uncertainties. In a fluid environment where financial
system conditions may unexpectedly change, prudence is of the essence both for
policymakers and financial institutions.
Concerning the role of financial institutions and supervisory authorities in coping with the
financial turmoil, I would submit three observations. First, given the underlying factors of the
financial stress, and in order to re-establish confidence within the financial system, it is
crucial to promote a widespread consistent valuation of complex structured products as well
as an adequate disclosure by banks of their exposures, in particular related to the US
subprime mortgage sector. Second, I would welcome the efforts of the supervisory community,
namely through the Basel Committee on Banking Supervision and the Committee of
European Banking Supervisors, in keeping each other abreast of developments and in
considering jointly possible measures to contain the potential effects of the turmoil. Third, I
would underline the importance in stress situations, like the current one, of effective and
smooth cooperation and exchange of information between the supervisory authorities and
central banks.
As to the policy lessons to be learned in order to avoid the recurrence of similar disruptions in
the future, I would say that, while it is still early to draw firm conclusions, there is a common
understanding on the key issues requiring further analysis. In this respect, let me recall a few
topics. First, the need for the financial industry to provide more public information about
securitisation, credit risk transfer and complex structured products. Second, the need for
rating agencies to review their methodologies for complex structured products and to
address very seriously potential conflicts of interest. Third, the need for investors to review
their investment behaviour excessively reliant on ratings. Fourth, the need for supervisors to
implement the new capital framework under Basel II as rapidly and effectively as possible
and to reflect on possible improvements of the framework, including the enhancements of the
supervisory regime for liquidity risk. In this context, I should mention that the ECB with the
assistance of the Banking Supervision Committee is carrying out work on banks'
stresstesting and contingency funding plans.
On all the issues mentioned above, work is already under way at both the international and
European level. The ECB is strongly supportive of the work of the Financial Stability Forum,
as well as of the European initiatives discussed in the ECOFIN Council. In this context, I
would like to once again stress the importance of effective cooperation in any policy actions
to be taken at the international level.
The impact of globalisation on price developments
Ladies and gentlemen, let me turn to the impact of globalisation on price developments. As a
preface, let me say that while globalisation could influence aggregate prices in several ways,
such impacts are limited to the short term given that inflation is ultimately a monetary
phenomenon.
The direct, and perhaps most visible effect of globalisation for consumers, is its implication
for relative prices. On the one hand, globalisation has dampened increases in euro area
import prices of manufactured goods given a rising share of imports from lower-cost
countries such as China and the new EU Member States. On the other hand, rising demand
associated with globalisation has contributed to the significant increases observed in world
energy and other commodity prices. Although such relative price shocks do not necessarily
affect inflation, prolonged short term impacts of sizeable relative price shocks could result, for
instance, from adjustment frictions in the economy. Empirical studies for the euro area have
tended to suggest a small dampening influence of trade openness on prices in the early part
of this decade, though globalisation's contribution to recent movements in commodity prices
- particularly energy and food - has had a significant offsetting upward impact on prices.
This warrants close monitoring, in particular given the risks of second round effects. In case
of food related commodities, it also underlines the importance of efficient supply side
adjustment in agricultural commodity markets.
A separate but nonetheless potentially equally important channel through which globalisation
can affect inflation involves the indirect price impact of increased competitive pressures, with
two main aspects. First, in principle it could contribute to compressing firms' price-cost
markups as competitive forces resulting from trade openness would depress profit mark-ups of
domestic firms competing with international firms. In practice, however, such effects have
been hard to identify and, indeed, aggregate profitability has remained high. Second, in
principle competition associated with globalisation could alter the responsiveness of prices to
costs or measures of economic slack, or imply a greater role for foreign conditions in the
inflation process. In practice, it would appear that such responsiveness has not increased
over the last decade, while empirical evidence supporting a growing role of global measures
of economic slack in the inflation process of the euro area and other advanced economies
has been limited.
On balance, not only is the net effect of globalisation on euro area prices difficult to
accurately gauge, but it may also be changing through time. For this reason, the ECB
continues to actively monitor possible ongoing changes in the inflation process. At the same
time, efficient adjustment can be best facilitated by focusing on price stability and continuing
to solidly anchor inflation expectations in the face of considerable relative price shocks.
Developments in the real estate sector
Let me conclude with some remarks on residential property prices. As with other asset
prices, residential property prices are closely monitored by the ECB in terms of our economic
analysis. Within this context, while we take the euro area real estate sector into account in
assessing risks to price stability, we certainly do not target house prices, or for that matter,
any other asset prices. We do monitor asset prices closely because of the potentially high
costs for price stability and for the economy as a whole that are associated with strong
appreciations and rapid reversals in asset prices. Also, our monetary analysis covers the
monitoring of money and credit which often reflect the evolution of prices and house
purchases. In this sense, a strategy which on top of our economic analysis regularly
assesses money and credit developments has an important benefit on the monitoring side in
that it can contribute to identifying and limiting the emergence of unsustainable
developments in asset prices.
In terms of recent developments in the euro area real estate sector, the latest available data
on house prices appears to support the notion of a cooling in euro area housing market
developments after a prolonged period of unusually high growth rates in many euro area
countries. That said, house price growth generally remains relatively buoyant in the euro
area on average when seen in historical perspective - notwithstanding considerable
heterogeneity in underlying country developments. The outlook for the euro area as a whole
remains that of a soft landing, as price increases moderate gradually and further
developments evolve in line with fundamentals. Within this context, a continued moderation
of residential investment would also be likely.
The above economic assessment is complemented by information from our monetary
assessment, in particular that the annual growth rate of loans to households was in October
at 6.8%, from 7.0% in the third quarter and 7.5% in the second quarter. In this sense, there is
no indication that the financial market turmoil has, as yet, limited lending to households, the
moderation of which started as long ago as the second quarter of 2006. I am now at your
disposal for questions.