• ECB kept policy rates on hold as expected and Trichet noted that the judgment today is very close to the judgment a month ago.

  • Nevertheless, Trichet mentioned several upside risks and it appears that the ECB’s assessment of the economic situation is slowly becoming more positive.

  • Trichet said that he tends to see the modest demand at the 12-month auction in September as a sign that we are progressing towards a more normal market functioning, but drew no firm conclusion.

  • It seems that the ECB is becoming increasingly concerned about fiscal sustainability. The wording on fiscal policy is slowly becoming harsher.

  • Today’s press conference was in line with our expectations. Thus we continue to anticipate that the ECB will follow the exit strategy we have previously outlined. 

Growth outlook has improved slightly

The ECB seems to have become slightly more positive on the economic situation than they
were a month ago, although Trichet specifically said that “We have a judgment today that is
very close to our judgment a month ago”.
First of all we got a positive message when Trichet explicitly said that exports will add to
growth, that stimulus will help the financial system and that a recovery in the inventory cycle
will contribute to growth in H2 2010.
Then Trichet listed a number of upside risks, namely that "there may be stronger than
anticipated effects stemming from the extensive macroeconomic stimulus being provided and
other policy measures taken. Confidence may also improve more quickly, the labour market
deterioration may be less marked than previously expected, and foreign demand may prove to
stronger than projected.”

He also noted downside risks of course, saying that "On the downside, concerns remain
relating to a stronger or more protracted negative feedback loop between the real economy and
the financial sector, renewed increases in oil and other commodity prices, the intensification of
protectionist pressures, and possibility of a disorderly correction of global imbalances.
Furthermore, increases in indirect taxation and administrative prices may be stronger than
currently expected owing to the need of fiscal consolidation in the coming years."

Trichet again noted that we have a bumpy road ahead. It is important to keep in mind that a
couple of months with positive data will not be enough for the ECB to become confident that
the recovery is on track and roll back stimulus.

Inflation expectations remain well anchored


On inflation Trichet reiterated in the introductory statement that “over the policy relevant
horizon, inflation is expected to remain in positive territory with overall price and cost
developments staying subdued, reflecting ongoing subdued sluggish demand in the euro area
and elsewhere." The beginning of the rate hiking cycle will not be imminent as long as the
ECB sticks to this sentence and does not add significant upside risks to their medium term
inflation forecast.

Asked about the recent increase in 5-year inflation expectations, Trichet said that “If we had
another turn in inflationary expectations upward then that would be incorporated into medium
and long term market rates, and we would be in a financial environment which would be much
more adverse for the recovery that we are already in.” He noted that the ECB looks at many
inflationary measures and that inflationary expectations have been very well anchored during
the crisis. All in all he did not seem very concerned about the spike in 5-year inflation
expectations although the ECB is certainly keeping a close eye on this.  

12-month auction interpreted as a good sign


Trichet said that he tends to see the modest EUR 75bn demand at the September 12-month
auction as a signal that we're progressively – perhaps – going back to a more normal
functioning of our market, but emphasised that he drew no definitive conclusion. We believe
that the modest demand reflects that market rates have fallen to very low levels and thus the
auction was not as attractive as the one in June and also that the market has plenty of liquidity
as it is and is functioning better.
Requested about the calendar for 12-month auctions next year, Trichet said that he will tell
when time comes. We expect that the 12-month auction in December will be the last and that it
will come with a spread.

Exit strategy


Trichet did not really give us any new information on the ECB exit strategy. Keeping in line
with previous messages he said that “Once the macroeconomic environment improves, the
Governing Council will make sure that the measures taken are removed in a timely fashion and
that the liquidity provided is absorbed in order to counter effectively any threat to price
stability over the medium to longer term."
It seems that the ECB is becoming increasingly concerned that fiscal sustainability could move
into dangerous territory in some countries. It is almost a reflex for central bankers to ask for
prudent fiscal policies, but the wording on fiscal policy is slowly becoming harsher. Today
Trichet said that “the need for an ambitious and realistic fiscal exit and consolidation strategies
is becoming increasingly pressing. It's vital that governments put in place concrete structural
measures and convincingly communicate that they are committed to ensuring the sustainability
of public finances”.
Trichet was also more specific than we are used to when he outlined that consolidation efforts
should be stepped up in 2011, and the need to exceed significantly the benchmark of 0.5% of
GDP per annum set in the Stability and Growth Pact. He then specifically recommended that
in countries with high deficits and/or debt ratios, the annual structural adjustment should reach
at least 1% of GDP.

Exchange rate


Little new was said on the exchange rate. On the strong dollar policy Trichet noted that “when
Bernanke says that a strong dollar is in the interest of the U.S. economy and that they are
pursuing a strong dollar policy, it is a judgment that is important for us and for the global
economy."