Considering all the new information and analyses which have become available since our meeting on 5 August 2010, we continue to expect price developments to remain moderate over the policy-relevant medium-term horizon, benefiting from low domestic price pressures. Recent economic data for the euro area have been stronger than expected, partly owing to temporary factors. Looking ahead, the recovery should proceed at a moderate pace, with uncertainty still prevailing. A cross-check of the outcome of our economic analysis with that of the monetary analysis confirms that inflationary pressures over the medium term remain contained, as suggested by weak money and credit growth. Overall, we expect price stability to be maintained over the medium term, thereby supporting the purchasing power of euro area households. Inflation expectations remain firmly anchored in line with our aim of keeping inflation rates below, but close to, 2% over the medium term. The firm anchoring of inflation expectations remains of the essence. Turning to fiscal policies, current developments at the euro area aggregate level appear to be broadly in line with previous expectations. At the country level, any positive fiscal developments that may emerge, reflecting factors such as a more favourable than expected macroeconomic environment, should be exploited to make faster progress with fiscal consolidation. At the same time, in countries where there is still a need to take additional specific measures to achieve consolidation targets, such measures should be adopted swiftly to ensure that consolidation commitments are fulfilled.

The subdued developments in money and loan growth continue to support the assessment that the underlying pace of monetary expansion is moderate and that inflationary pressures over the medium term are contained. The downward impact of the steep yield curve on monetary growth, which is reflected in the allocation of funds into longer-term deposits and securities outside M3, is gradually waning. Moreover, the impact of the narrow spreads between different short-term interest rates on the growth of the components of M3 is continuing to diminish. As a result, the annual growth  2  BIS Review 113/2010  rate of M1 has continued to moderate from high levels, and stood at 8.1% in July 2010, while the annual growth rate of other short-term deposits has become less negative. The still weak annual growth rate of bank loans to the non-financial private sector continues to conceal positive growth in loans to households and diminishing negative annual growth in loans to non-financial corporations. These developments are consistent with a normal, lagged response of loan developments to economic activity over the business cycle. Given the subdued developments in banks’ overall balance sheets, the challenge remains for banks to expand the availability of credit to the non-financial sector when demand picks up. Where necessary, to address this challenge, banks should retain earnings, turn to the market to strengthen further their capital bases or take full advantage of government support measures for recapitalisation. To sum up, the current key ECB interest rates remain appropriate.