European Central Bank President Jean-Claude Trichet being interviewed by a German television network, on Wednesday, March 26, 2008.

ECB President Jean-Claude Trichet reaffirmed the European Central Bank's commitment to Eurozone price stability and fighting inflation in an interview with a German television network, broadcast on Wednesday. The ECB President had said earlier to the European Parliament: "If we had reduced rates for a reason other than maintaining price stability, we would in effect have been asking our fellow citizens to subsidise the banks via their suffering from inflation." 

"In this phase, the European Central Bank is trying, more than anything else, to prevent the inflationary expectations," Trichet said in English, according to a report on the ARD TV web site.

"We are there to guarantee medium-term price stability," Trichet said.

"That is exactly what the Germans and all the other citizens demand from us. And on the other hand we look at the interest rates that are set to guarantee medium-term price stability," he said.

Trichet said that banks should pay for their mistakes.

"We have not to facilitate the life of those who made mistakes," Trichet said. "They have to pay for their mistakes. Not only because it would be unjust if they did not pay a price for their mistakes."

Video and report from German TV

In his quarterly testimony to the Economic and Monetary Affairs Committee of the European Parliament, Jean-Claude Trichet on Wednesday was buoyed by unexpected rises in German and French business confidence (see links at bottom of page).

The surprise improvement in the Eurozone's two biggest economies, signalled that the fallout from the slowing US economy and rising euro, has so far been limited.

The data coincided with a strong defence by Jean-Claude Trichet, of the bank’s decision to leave its main interest rate unchanged despite sweeping cuts by the US Federal Reserve.

Eurozone inflation was at a 4-year high of 3.3% in February and the ECB President said that it would remain high for longer than expected and significantly above 2% for most of this year.

“Decoupling is impossible because we’re in a globalised world, but Europe’s resilience has improved due to structural reforms,” Klaus Regling, head of the European Commission’s Economics Department, to journalists in Frankfurt.

The Munich-based Ifo Institute said its German business climate index had risen for the third consecutive month, boosted by greater optimism about business conditions but also an improvement in expectations for the next six months. At 104.8 in March, after 104.1 in February, the index was at its highest since August.

In France, the national statistics office Insee said that its business confidence index rose from 107 in February to 109 this month – the highest level this year.

Christine Lagarde, France's Finance Minister, said the economy was “resisting rather well” the global crisis, even if the government had cut its growth forecast for this year. Reforms by the new government “were ahead of time and a smart move”, she said.

Jean-Claude Trichet said that inflation would stay relatively high for longer than expected and that the outlook for growth was "unusually uncertain" when he met the Economic and Monetary Affairs Committee of the European Parliament for the first of four Monetary Dialogue sessions in 2008. He was questioned by MEPs about the ECB's response to the financial market turmoil and its focus on controlling inflation.

The ECB President told MEPs that risks to the medium term outlook for inflation were on the upside and "the period of relatively high inflation rates will be more protracted than previously expected." He said  it was imperative that "second round effects on price and wage-setting from current inflation rates are prevented. This is the key to preserving price stability in the medium term and thereby the purchasing power of all euro area citizens." While ongoing growth was expected, albeit at slower rates than previously projected, "uncertainty about the prospects for economic growth remains unusually high." 
 
On conclusions to draw from the financial market turmoil, Mr Trichet said, "I would call for a further significant change of culture at the national, European and global level.  I would sum up this culture change with two words: transparency and anti-cyclicality." (full text of Trichet's opening statement.)
 
Improving behaviour in the financial markets
 
German MEP Alexander Radwan asked about herd behaviour and the need for transparency in financial markets. Would politicians need to act to provide a framework for a change in behaviour?   Trichet responded that "the observation that transparency is of the essence is not new"; it had been the key to avoiding contagion during the Asian crisis, and was so now: "where the is absence of transparency, it is conducive to hectic, herd behaviour and turbulence on markets."  Public authorities, he said, "have to create an environment which is conducive for private institutions to behave as effectively as possible.  The current situation is not appropriate and needs to improve."
 
A number of MEPs, including Committee Chair Pervenche Berès pressed Trichet on whether it was time to look beyond codes of conduct or other measures of self-regulation and turn to regulation by public authorities to solve market failures.  The ECB President said "We always need to ask market participants to improve behaviour themselves. If their response is not convincing, or if they cannot do it, then the time has come for regulation.  I don't rule out regulation ex ante but it is good practice to see whether you can proceed by setting out best principles and benchmarking."  He also emphasised the need to work with other jurisdictions, notably the US, on such issues, something he said was going on via the Financial Stability Forum.
 
An "ongoing market correction"
 
Was the worst of the current financial market crisis over, asked Wolf Klinz?  "The present situation is of an ongoing process of very significant market correction with episodes of turbulence, a high level of volatility and overshooting.  This market correction is ongoing" said the ECB President.
 
Robert Goebbels contrasted the ECB's holding of interest rates with the cuts made by the Federal Reserve in the US.  He spoke of the ECB providing "unlimited liquidity" to banks – was this not encouraging further debt by assuring banks that they could always rely on the ECB, when a cut in interest rates might have helped both the financial sector as necessary and the wider economy?  Trichet strongly disagreed: "If we had reduced rates for a reason other than maintaining price stability, we would in effect have been asking our fellow citizens to subsidise the banks via their suffering from inflation."  He noted that the ECB and the Fed were operating in different environments, facing different shocks in different economies.
 
Inflation and purchasing power
 
Noting that the ECB's projections showed inflation above its target in the months ahead, John Purvis asked whether other factors were now influencing interest rate decisions. "Resolutely no," said Trichet. "If we have maintained rates at their present level, it is because we believe this level corresponds to what is necessary to deliver price stability in the medium term... We have only one needle in our compass."
 
Donatella Gottardi asked what could be done to maintain people's purchasing power and prevent the emergence of more "working poor". Trichet stressed that in normal time pay rises should be linked to improving productivity. But in times of external price shocks the economy had to adjust to transferring more to external suppliers. "Once that higher price is there, if you do not accept it as the price it is, you are paving the way for an inflationary spiral and increasing unemployment... Mass unemployment in Europe started after a very bad policy reaction to the first oil price shock in the 70s."

Trichet for the first time defined the period over which the ECB aims to keep inflation under control. The ECB has long stated that its aim is to keep the annual Eurozone inflation rate “below but close” to 2% over the medium term. told the Committee that “medium term” meant 18 to 24 months.

Spain’s residential property market is heading for a hard landing

The Eurozone's fourth largest economy Spain' is undergoing a severe housing contraction and on Wednesday, the National Statistics Institute (INE) reported that house sales for January dropped 27% year-on-year and total mortgage lending fell almost 28% to €13.4bn.

INE said that sales of homes and apartments suffered the biggest decrease in January, down more than 35% year-on-year to 32,400 units. New home sales in January fell almost 15% to 29,400.

The FT reports that according to some analysts, Wednesday’s figures reflect only part of the story, as they exclude some off-plan homes sales.

Citi, the investment bank, estimated in a report that these were down by as much as 60% year-on-year at some companies, as it forecast a 25% decline in net profits this year at Realia, one of Spain’s biggest listed property groups.

A report by Aguirre Newman, the property consultants, says that residential estate developments in some parts of the Mediterranean coastnow take an average of four years to sell, compared with a few days at the height of the property boom four years ago. About half of the new apartments on the Costa del Sol are sitting unsold, it says.

More than four million new homes have been built in Spain in the past decade.

The Economist says that Spain has depended heavily on construction, which accounts for as much as 18% of GDP, nearly twice the share in other European countries.In recent years Spain has built more new houses than Britain, France and Germany put together.