Orphanides Says ECB Sees No Need to Alter Policy Accommodation

European Central Bank Governing Council member Athanasios Orphanides, who also heads the central bank of Cyprus, comments on monetary policy, inflation and growth in the euro area.

He spoke in an interview on Jan. 14 in Frankfurt.

On how concerned he is about euro-area inflation:

“As you know, the Governing Council acknowledged an increase in inflation that is largely due to increases in energy prices. Overall inflation will likely be somewhat higher in the near term than was anticipated earlier. This is something that clearly merits very close monitoring. At the same time, the introductory statement reaffirmed that the assessment of the Governing Council is that price developments will remain in line with price stability over the policy relevant horizon.”

“I should note that readings above 2 percent for overall inflation shouldn’t be seen as unusual in light of the volatility that has been exhibited in commodity prices in the recent past. This volatility implies that overall inflation may at times be somewhat higher and at other times somewhat lower than we would like to see. You may recall we had negative inflation rates not too long ago.”

“Measures of the underlying inflation rate remain rather low. There are a number of measures for underlying inflation. One is core inflation which excludes the influence of volatile energy and food prices. Another element under consideration at the moment is that some member states have increased VAT taxes which will also temporarily boost overall inflation. Again, we need to monitor these developments very closely.”

On whether he sees a real risk of second-round effects, given workers in Germany are already demanded wage increases of up to 7 percent:

“You mentioned specific members of the euro area and I should point out that we have some divergences across the euro area. This is not only regarding inflation, but also regarding economic activity and the health of the economy. Our objective is to maintain price stability in the euro area as a whole and this is our key guide.”

“We always closely monitor developments and clearly it’s essential to avoid second-round effects that could result from temporary increases in inflation.”

“In some countries in the euro area, the economy is doing quite well, which may be creating some wage pressures. I would, however, note that at the same time there are other countries in the euro area where the economy is still in recovery and we do not see similar labour pressures. There is more heterogeneity in the euro area at the moment than we would typically expect. This is one of the legacies of the severe crisis we’ve been going through.”

“Regarding inflation expectations and the possibility of second-round effects, clearly it is absolutely crucial to maintain well-anchored inflation expectations in line with our mandate. This is of the essence; this is why we pay so much attention to developments in inflation expectations.”

“The next Survey of Professional Forecasters survey is being conducted later in January and the results will be published next month. This is one of the surveys that we monitor closely to see whether inflation expectations remain as well anchored as we would like them to be. Let me remind you that despite the fluctuations in actual inflation over the past few years, the survey has shown that long-term inflation expectations have consistently been in line with our price stability mandate.”

On market-based inflation expectations edging up:

“It’s true that market-based inflation expectation measures have edged up in the past few weeks. However, they are still on the low side, relative to historical averages.”

On whether it is more challenging now to find a one-size-fits-all monetary policy:

“Heterogeneity in the euro area is one factor that complicates the assessment of what is the most appropriate policy stance in the euro area as a whole. But again our mandate is to maintain price stability in the euro area as a whole. Although we take into account heterogeneity, we are faithful to our mandate.”

On market reaction to the ECB’s Jan. 13 policy statement:

“The Governing Council assesses that policy rates remain appropriate. We do sometimes see that the interpretation of policy statements may indicate some overreaction to the underlying message.”

“In my view, the important message to be taken out of our decision and statement was to acknowledge that, largely due to an increase in energy prices, overall inflation is somewhat higher than we would like it to be, but at the same time we expect that overall inflation will actually be coming down. We do not see any need to change the view that the current degree of accommodation in our monetary policy is consistent with price stability in the euro area in the medium term.”

On whether the ECB’s inflation comments were a verbal intervention so that the ECB won’t have to act later in the year:

“I do not see the introductory statement as having been overly hawkish. I do not agree with your assessment on this. I do agree that it is important to remind everyone of our commitment to our primary mandate, especially when we see unexpected increases in overall inflation that could potentially create concerns in the minds of households and businesses.”

On the likelihood of a rate increase before the fourth quarter:

“In the Governing Council’s view, policy rates remain appropriate and, as I have stated in the past, I do not find it helpful to try and forecast interest-rate changes well into the future.”

“Future monetary policy is conditional on changes in the evolution of the economy. Our primary goal is price stability and that is why we always monitor price developments, inflation expectations and other influences on inflation forecasts closely.”

“For the monetary policy relevant horizon, the risks to price stability appear to be balanced at the moment. Future decisions will be conditional on changes to this view.”

“It is never appropriate to overreact to any single month’s data point even if that is adversely surprising like the inflation reading we’ve had. We must always reassess the outlook carefully and respond appropriately. It’s after such analysis that we find that rates remain appropriate.”

On whether he agrees with Trichet that standard and non-standard policy measures are disconnected and that the ECB can raise rates while maintaining liquidity measures:

“There are different ways to describe conceptually the inter-linkages between conventional and unconventional monetary policy. Unconventional monetary policy has two components. The first is to facilitate liquidity provision and, for some unconventional measures, improve market functioning. This component of unconventional policy is also important for restoring the transmission mechanism.”

“At the same time, unconventional measures also influence the stance of monetary policy beyond what is normally reflected in the setting of the policy rates. In that sense, there is an inter-relation that needs to be taken into account.”

“That said, I fully agree with the President that in principle, as this may be necessary in the coming months, we could see a further adjustment of the unconventional measures by continuing the phasing out of some of the measures we have implemented, which were always temporary in nature. At the same time, if needed, we could adjust our policy rates while some of these unconventional measures remain in place.”

“One of the difficulties we have encountered, particularly with the sovereign crisis in the euro area, is a greater divergence of the cost of financing that businesses, households and governments face in different parts of the euro area, compared to what we saw in the past. This is an element that complicates monetary policy.”

On whether the ECB will resume its exit in the second quarter:

“This is something we need to consider when the time comes. We have phased out a number of liquidity provision measures we had already. We no longer have a 12-month operation, we no longer have a 6-month operation, so the operations we currently have, including the 3-month operation, are operations that we had even before the crisis as part of our monetary policy toolkit.”

“Regarding the modalities of the provision of liquidity these are evaluated and depend on what we see as the potential need. We are sensitive to the liquidity needs of the banks in the euro area.”

On how he views the liquidity needs of euro-area banks and how the ECB will deal with addicted banks:

“The only thing I want to mention is that we continue to see a greater heterogeneity of funding costs around the euro area and we’ll need to be sensitive to these differences.”

“The money market is still not functioning ideally and we still see some fragmentation in the operation of the money market across the euro area. This creates different costs of financing for banks and consequently for businesses and households across the euro area.”

On whether the ECB’s bond purchases have worked:

“With regard to the SMP, I think the presence of the program has been effective in improving somewhat the transmission mechanism of monetary policy which was one of the objectives.”

“We have observed in the past several months periods of extreme tension in sovereign markets that could not be justified in terms of the evolution of fundamentals of the euro area economies. The SMP has helped in reducing some of these tensions.”

On whether it’s the ECB’s job to buy government bonds and whether it would be better for the European Financial Stability Facility to buy them:

“It is the ECB’s job to use all monetary policy tools in order to achieve its objectives.”

“We should acknowledge that the tensions we have seen in the euro area over the past year reflect, to some extent, weaknesses in the governance of the euro area and concerns about the stability mechanism that is in place in the euro area. It is extremely important at this juncture to make maximum effort to improve the underlying stability mechanism.”

On how the stability mechanism can be improved:

“We need an efficient and effective macroeconomic insurance framework and ideally this is what the European stability mechanism could deliver.”

“To be effective, it is crucial for any insurance mechanism to avoid moral hazard. One of the lessons from our experience in the past several years is the weakness of enforcing the Stability and Growth Pact. Unfortunately not all euro-area governments have lived up to their responsibilities.”

“It is important to have the proper incentives for euro-area governments to fully respect the Stability and Growth Pact.”

“Two things could help in this regard. The first is strong surveillance, as intrusive as needed, of fiscal reporting and fiscal projections and institutions that ensure the independence of fiscal reporting. This is imperative in my mind because we have seen, for example in the case of the Greek government over the past several years, that there has been reporting of a fiscal situation that was not up to the expected standards.”

“The second one is meaningful sanctions in order to have the proper incentives for governments to fully respect their responsibilities and avoid the temptation that may appear from time to time for political concerns to deviate from their responsibility.”

“To be efficient, a macroeconomic insurance mechanism must contain costs. One way to think about the ideal institutional design is to consider a framework that would minimise the total cost of financing in the euro area, for governments, households and businesses.”

“If we do not have a structure that achieves that, then we have an inefficient structure that is punishing households and businesses with costs of financing that may be considerably higher than they have to be in some parts of the euro area.”

On whether he is frustrated with governments, given the ECB has had to step into the breach during the crisis:

“In my view the management of the crisis in the euro area over the past year has been less than ideal. But that’s the past. Looking forward is more important. We must realize how important it is to aim for a large improvement in the current governance structure and the stability mechanism in the euro area.”

“It is critical that this improvement be made as quickly as possible and be as meaningful as possible. This is because financial markets are forward looking and as a result uncertainty about the stability mechanism that would be operational in 5 or 10 or 15 years influences behaviour of markets right now.”

“It is important to resolve that uncertainty by designing as quickly as possible an efficient and effective stabilisation mechanism because that would have a calming effect on markets right away and would greatly facilitate the recovery in the euro area, especially in those countries that are under greater market pressure at present.”

“I don’t know whether that implicitly indicates a level of frustration.”

On whether the EFSF should be enlarged:

“The EFSF is a structure that has been created as a temporary measure for a three year period; it is true it could also be improved in how it can help the stabilization effort at present. It is more important to focus on the long term.”

On whether the EFSF should buy government bonds:

“Ideally, flexibility that would allow a stability mechanism to be more effective would be desirable.”

On whether that would include the EFSF being able to buy government bonds:

“I believe that that would be one way to have additional flexibility that at times might be found useful.”

On whether the EFSF buying government bonds would reduce the need for the ECB to buy them:

“To the extent euro area governments improve the effectiveness of the stabilisation facility and this relieves some market tensions, this would facilitate the ECB’s task. Let me remind you that the ECB decided to initiate the SMP and took other non-standard measures to address market dysfunction that hampered the monetary transmission mechanism.”

“If the EFSF were to buy government bonds and that improved the functioning of the monetary policy transmission mechanism, that might render some of the ECB’s non-standard measures no longer necessary.”

On the fiscal situation in Cyprus and whether his home country is the next Greece or the next Portugal:

“The debt to GDP ratio for Cyprus is smaller than the average for the euro area so the fiscal situation is clearly not as dire.”

“That said, the fiscal situation in a number of euro-area economies is a cause of concern. The negative environment regarding sovereign debt in the euro-area markets makes it even more important now to strive for sustained improvements in fiscal finances. This is true of a number of countries in the euro area and this is true of Cyprus.”

“Governments must be ahead of the curve and to achieve this some governments in the euro area, including Cyprus, need to set more ambitious fiscal consolidation targets. They need to speed up structural reforms and they need to emphasize sustained containment of government expenditures rather than rely on temporary revenue increases.”

“I mention this overall, because it’s valid for a number of governments in the euro area, including Cyprus.”

On the Moody’s statement:

“I would first mention that the decision by Moody’s to place Cyprus’s bond rating under review for a possible downgrade was not entirely unexpected.”

“It is widely recognized that the deterioration of government finances in the past three years in Cyprus, as it has been elsewhere in the euro area, has been severe.”

“Moody’s appears concerned that the deficit is of a structural nature, particularly as they note it’s related to increases in the public sector payroll and social transfers.

“They also note that the 2011 budget that was discussed and approved by parliament last month does not address these challenges over the medium to longer term.”

“With the level of government debt in Cyprus relatively low compared to the average for the euro area, correcting the fiscal imbalances can be achieved with expenditure reductions that are not particularly severe. In this sense the fiscal consolidation that needs to be implemented could be done without imposing great hardship at the moment.”

“I would like to note that during the discussion of the 2011 budget the government pledged to work toward reforming the pension system and cost of living adjustments. These are two long overdue structural reforms that, in my view, would address to a large extent the concerns of the rating agencies. But it is imperative for the government to bring forward these reforms as they could address the concerns immediately and restore confidence in markets.”

“Overall, I would note that putting the government’s finances on a more solid footing over the long haul is particularly important for Cyprus because of its role as a regional financial centre with a well developed banking sector.”

On the stability of Cyprus’ banking sector and how concerned he is about exposure to the real-estate sector:

“The banking sector is sound, as has been the case throughout the turbulence. It is well capitalised. Moody’s acknowledges that the capitalisation and liquidity position of the banking sector are in good order. The strict prudential supervision framework we have always had, has served us well.”

“Macroprudential measures taken before the crisis helped protect the banking sector from an exuberant real estate market. In July 2007, before the turbulences began, the Central Bank tightened loan to value ratios on real estate loans in order to contain the risks associated with exposure to that sector. That decision made our system more resilient and this is an example of prudential supervision action we took in Cyprus that is now discussed as part of a toolkit that should be considered more broadly in Europe.”

“As you know, next week we will have the first meeting of the European Systemic Risk Board (ESRB) that has been established to monitor financial stability in the European Union overall and assess what macro-prudential measures could be considered to enhance financial stability. The action we took in Cyprus in 2007 is an example of the recommendations I foresee the ESRB will be considering making.”

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