Q. Is 2010 growth likely to be better than foreseen in the June staff forecasts?

The incoming data have been somewhat better than anticipated in earlier projections and I would not be surprised if the staff projections in September do show an improvement for the whole year 2010 compared to the previous projections.

Q. Do you see an improvement within the 0.7-1.3 pct range (from June) or beyond that?

I would say an improvement within the range.

Q. Will the buoyancy spill over into next year?

We will have to wait and see on that. The recovery remains uneven so we are pleased to see signs of improvement but we need to continue to monitor very carefully the prospects.

Q. Will a quick removal of government stimulus drag on growth and is this recovery self-sustaining?

In a number of countries in the euro area, the removal of economic stimulus at this stage could have a confidence-boosting effect that would not be a drag on growth. As we have observed, for a number of countries in the euro area, fiscal policy had become over-extended as a result of the fiscal accommodation during the crisis and we need to make sure that we have sufficient consolidation to put us back on a solid footing. With the overall improvement we have seen in the economy, most governments can afford to withdraw the fiscal stimulus without hampering the recovery. Indeed, putting fiscal finances in good order would be a development that would boost long-term growth prospects in many countries of the euro area.

Q. Inflation is picking up along with growth. Do you see the rate of inflation continuing to increase at a similar pace?

At present, headline HICP inflation is in line with our definition of price stability. Inflation dynamics over the past many months have been influenced by the swings in energy prices and I am not worried about the recent increases. The underlying trend in inflation suggests that inflation remains well-contained and I see upside risks to inflation as contained as well. The underlying trend in inflation excluding the highly volatile energy component, has been more stable and considerably lower than where it has been in the past several years. So I do not see any major upside risks to inflation despite the increase in the past few months.

Q. Is inflation still too low currently? Do you see downside risks?

We need to monitor carefully the economic recovery. If the economic recovery continues, which is the baseline scenario reflected in various forecasts by international organizations and by the staff, then I do not see significant deflation concerns. Again, we need to be mindful both of inflation and of deflation risks. Our definition of price stability is well known, to keep inflation close to but below 2 percent, and in my view we need to evaluate the risks symmetrically around our objective.

Q. Are risks symmetrical at the moment?

“Broadly balanced” is an appropriate characterization of the risks at the moment. I do not see major risks on the upside and I do not see major risks of deflation.

Q. Does the next survey of professional forecasters show any drift up in inflation expectations?

There are no indications that medium to long-term expectations have been dislodged. In my reading, inflation expectations remain very well anchored and in line with price stability. You will see details published in the monthly bulletin next week.

Q. You said recently central banks have unlimited ammunition. What ammunition could be deployed next? Does the ECB need to use more ammunition at the moment?

That was in response to concerns raised repeatedly last year by some observers that a central bank may face difficulties in implementing additional monetary policy easing if the nominal interest rates are very close to zero. My point was that there is no such constraint on a central bank implementing additional monetary easing, for example if it were needed to counter deflation prospects. The situation we are facing now is not one where this question is as pertinent as it was a year ago because the economy has been recovering in recent months. But as a matter of principle, it is something we should have in mind if ever it becomes an issue again. To be more precise about what more a central bank could do, I would just remind you of the unconventional monetary policy easing that the ECB as well as some other central banks have implemented during the crisis over the past couple of years.

One example has been our covered bond purchase programme, which managed to facilitate improved activity in the covered bond market but also, being an asset purchase programme, reflected an unconventional policy easing. Let me also remind you of our decision last year to provide unlimited liquidity at our key rate for up to 12 months, much longer than our usual operations. Extending liquidity at such long horizons helped ease tensions in money markets and helped banks with their liquidity planning, but also constituted additional monetary policy easing.

Q. Mr Trichet said he was happy with the government bond purchase programme, does that vindicate the ECB’s decision in the face of criticism, including from some of your colleagues?

I think it would be a mistake to over-interpret the genuine debate that we always have when we try to figure out the best policy action at any point in time. It is natural to have differences of opinion at times but the Governing Council is a collegial body and we reach our decisions after we have an honest debate. So you should not over-interpret the debates that take place.

The purpose of initiating the programme was to counter dysfunction in specific sectors of the market. It was an unusual situation, that’s why we engaged in very targeted government bond purchases. I am pleased with the outcome of the programme so far and indeed the fact that we have seen improvement in market functions and purchases have virtually stopped is something I take as evidence that the programme has been successful.

Q. Does that mean it could be terminated any time soon?

In my view, the presence of the programme can have a stabilizing influence in markets even if no purchases are taking place whatsoever. At the moment we have virtually no purchases. To the extent that the programme can have a stabilizing influence even with no purchases, it would appear prudent to keep the programme in place even if no need for purchases going forward is anticipated.

Q. Is that what you anticipate?

This is an argument against discontinuing the programme at present. Even if I anticipated no need for purchases, because the existence of the programme can have a stabilizing influence on markets, it would not be prudent to discontinue it.

Q. So even if it is not deployed, you would leave the option there to use if necessary?

That would be the prudent course of action.

Q. Do you anticipate any need for the purchase pace to be ramped up again?

I am very pleased that as a result of the improvement in market functioning purchases have virtually stopped. We have been experiencing a lot of turbulence in markets and one cannot exclude that we may have uncertainty flare up once again, and we have to be prepared for that. But I must say that I am pleased with the improvement in markets in recent weeks and if things continue the way they have been going over the past few weeks, that would be fairly good evidence of normalization that would not warrant increasing purchases.

Q. Will the ECB sell or lend back the bonds bought?

That’s not something that requires consideration at the moment.

Q. Does the fact the weekly deposits can be used as collateral for new loans not lead to a net increase in liquidity?

It’s hard to make a distinction at the moment with a fixed-rate, full allotment policy in place, and that’s why it’s important to communicate the principle of the programme. We do withdraw the liquidity that is associated with the programme. If the banking system needs additional liquidity, as long as we are in a fixed-rate, full allotment mode, the liquidity can be obtained.

Q. Once you return to normal liquidity provision, will the programme lead to a net increase in liquidity?

If we were no longer in fixed-rate full allotment mode, there would be tendering for liquidity so we would control the liquidity in the system once we are in that environment.

Q. Short-term market interest rates have been rising recently. Would it be correct to characterize this as a de facto tightening of monetary conditions?

We monitor closely conditions in money markets as well as other markets which influence monetary conditions. Money market rates have inched up somewhat partly as a result of the shortening of the maturity of our refinancing operations and a normalization in money markets. I would note that we continue to supply liquidity generously at a fixed rate. We remain sensitive to the liquidity needs in the banking sector and, as we have been doing since the beginning of the crisis, we will continue to provide liquidity as necessary, accounting for needs in the system and aiming towards an appropriately accommodative policy stance.

Q. Is there still a need for fixed-rate, full allotment operations past September and October?

As President Trichet said, we will be announcing our next steps at the next meeting.

Q. Are you worried about banks’ ability to cope if liquidity supplies continue to tail off?

We remain sensitive to the liquidity needs of the banking sector. We will continue to provide liquidity as necessary. We have been sensitive to this need since the beginning of the crisis. The president said yesterday we would continue to do what is necessary and appropriate on liquidity. I fully agree with that.

Q. Are you concerned about banks remaining dependent on ECB funding? Is it better to err on the side of caution on banks’ needs for liquidity, or on the side of avoiding dependency on ECB funding?

In this context, I should first note that I am very pleased with the results of the bank stress exercise that showed the resilience of the banking system in the EU and the euro area in particular. One of the important elements of the stress tests exercise was the commitment by governments to step in when needed --- in those few cases that banks required additional assistance were not able to get additional capitalization from markets --- to ensure that the system remains well capitalized. I bring this up because these developments suggest that going forward, we should not be as concerned as we were a year ago, or earlier, about banks over-relying on the ECB for liquidity. In this context, I could also point out that we have seen a significant increase in activity in the interbank market. The volume in the EONIA market has about doubled, which is a very good sign of normalization.

Q. Does that mean full allotment, fixed-rate liquidity can continue without the risk of reliance?

As long as we consider the fixed-rate, full allotment policy at some horizon to be appropriate, we will continue it.

Q. Barring any shocks to markets, what sort of timeframe do you see for a normalization of the interest rate constellation in money markets?

What’s more important, in my view, is to get a sense of the determinants of the appropriate monetary policy stance. The key is to maintain appropriate monetary policy stimulus so our economy continues its recovery and we ensure that inflation developments are in line with our price stability objective. Policy accommodation should be removed when it poses a threat to our price stability objective, our primary goal. As I mentioned, at the moment inflation remains subdued and upside risks are contained.

Q. Is it fair to say you don’t see any urgency in pursuing the exit strategy?

At the moment inflation remains subdued and upside risks are contained, so I do not see an urgency in changing our monetary policy stance.

Q. Will the sequence of removal of policy measures be in the reverse order of introduction, ending with the standing facilities rate corridor?

That’s one logical possibility, but it’s not something this is the right time to discuss.

Greece:

Q. On the issue of Greece, the IMF, ECB and EC gave a very upbeat assessment on the progress. However can Greece avoid restructuring with debt reaching 150 percent at the end of the bailout period?

I was pleased to see the statement of the European Commission, the ECB and the IMF on the review mission that ended yesterday. Perhaps because I was one of the optimists on the success of this programme all along, I am not surprised by the strong start that has been made on the programme.

I would like to point out a couple of very important elements in the findings of the European Commission, the ECB and the IMF that I think are significant and also serve as useful lessons for others to draw on in the European Union.

The assessment notes impressive progress on structural reforms, including a far-reaching pension reform and labour market reform. The statement also suggests that restoring competitiveness and boosting potential growth remain critical to the programme’s success. This is the crux of the answer to your question about the so called inevitability of restructuring, that a number of analysts are still mentioning with respect to Greece.

In my view, it is incorrect to suggest that restructuring is inevitable. It is very simplistic because it does not take into account the strong, long -term potential for growth that could be realized in the Greek economy as a result of the structural adjustments that are taking place right now.

One of the biggest benefits of the commitment to the structural reforms that we have seen taking place in Greece over the past few months, is that it will boost potential output growth in Greece which will improve the long - term economic prospects of the country.

If these structural reforms are successfully implemented, as they seem to be at the moment, and growth prospects in the country increase significantly, it will be much easier to service the debt that is outstanding right now. Increased growth on its own would significantly reduce the projected debt to GDP ratios and make them less daunting than they appear to some analysts right now.

It is on the basis of this unrealized potential and the prospect that it could be realized if the structural reforms are implemented correctly, that makes me optimistic that there is no need for even considering restructuring.

Q. What do you think it would take in terms of fiscal progress to convince bond markets?

Here let me just point out, as the troika mission pointed out yesterday, that the Greek government is on track in consolidating its finances, I think this is what is important. After a very long period in which it was not clear whether the Greek government could deliver, the most convincing element for markets, I believe, is for the government to continue implementing what has been agreed and continue demonstrating with its actions that it has the resolve to implement the agreed programme.

Q. This is an extremely painful process for the Greek people. What is at stake?

The stakes are high. The stakes are whether the Greek government, by continuing the implementation of this programme, will help the Greek economy realise its unrealized potential, which would be tremendously beneficial to the Greek people as a whole over time. Backtracking in order to minimize short-term pain, unfortunately, at this time, will only have longer-term negative consequences that will be harmful to the Greek people overall. So the stakes are indeed quite high.

I am optimistic on Greece. I think the courage and determination the Greek government has shown to implement a programme destined to put the Greek economy back on track is commendable.

Cyprus:

Q. There has been a significant deterioration in public finances over the past 18 months. Are you happy with the efforts to put them back on the right track?

I agree with your assessment that there has been a significant worsening in the budget deficit. I must say that, since recognition of the problem is essential in designing its solution, the fact that the problem has been recognized and we are now observing a very active political debate about how to solve the problem, is a very healthy development.

Q. However debate has continued for 10 months and nothing has come of it. Parliament has rejected government attempts to raise taxes. Standard and Poor’s has also warned of a credit ratings downgrade. How damaging would a downgrade be for the economy?

Let me address the three elements in your question. The first element suggests that the widespread acknowledgement, the recognition of our fiscal problem, had already occurred last year. I want to dispute that. It is true that some analysts and we at the Central Bank were already warning about the deterioration in fiscal finances and the need for a correction, last year. However, this view was not universally accepted. For example, let me remind you that the government budget for 2010 that was discussed before parliament as late as December, suggested a rather optimistic picture for the outlook of public finances in Cyprus. A very healthy development is that the need for fiscal consolidation is now understood. I find it very important that it is now universally agreed by all involved that we do need to discuss, agree and implement as a country a fiscal consolidation programme. That is a very positive element.

Regarding the discussions that are taking place: It is true that insufficient progress has been made so far. As you mention, parliament has rejected plans for increasing taxes. However, I should point out that in the analysis that we have done at the Central Bank, we have seen that those plans were not sufficient to address the fiscal consolidation that needs to take place. My interpretation is that there was a call for the government, working together with parliament, to agree on a complete fiscal consolidation programme that would place appropriate emphasis on expenditure reduction, without hampering long-term growth prospects. I hope that such a programme will be agreed upon and implemented in the next few months, in the context of the discussions for the budget that will be prepared by government and presented to parliament in the fall.

I must say that Cyprus is in a better condition than most of our peers in the European Union to implement a fiscal consolidation plan at the moment. Our economy was very strong when we were preparing to enter into the euro, and as a result of following prudent policies for a number of years, we managed to reduce our debt to GDP ratio and actually register important surpluses with the introduction of the euro. So, it is only in the past two or so years that we have seen a significant deterioration in the fiscal finances, driven in large part by increases in non-productive government expenditures.

Because the problem, in large part, can be traced to decisions that have been taken in the past two years and the very solid fundamentals we had before then, I think it is quite manageable at the moment and I trust that our government, working with our parliament, will reverse the recent trend and put our public finances back onto a solid footing.

The third part of the question was the warning that we may be downgraded by rating agencies with a very specific warning by Standard and Poor’s: indeed we all recognize the consequences of that. This warning is just a symptom of the deterioration of our fiscal finances and the need for putting back our fiscal finances onto solid footing. It is a warning that we should also take very seriously because, if we do see a materialization of these downgrades, that would imply necessarily an increase in financing costs throughout the economy, which would be detrimental for growth prospects for our economy both in the short term and in the long term.

At the end of the day, we all recognize that policies that strengthen growth are the easiest policies to ensure that we will have a long - term improvement in fiscal finances, so, in my view, it is imperative that whatever actions are taken by government, avoid a deterioration in the long- term prospects of our economy.

Q. How confident are you Cyprus can meet its deficit target as sought by the European Commission?

Our initial conditions are much better than those of most of our peers in the European Union, so at the moment, it is not difficult to take the corrective measures. As always, the appropriate decisions require political courage and cooperation and I trust that we will see that political courage and cooperation to solve this problem and ensure the long - term growth prospects of the Cypriot economy.

What is important is to get the sequencing right, the government needs to present a complete consolidation plan that can be debated, decided and implemented.

Q. The government said that was done in April.

As I already mentioned, the programme I saw being presented to parliament was not a complete consolidation plan but primarily reflected an increase in taxes that was insufficient to cope with the need for fiscal adjustment. I have not yet seen a complete consolidation programme being presented before parliament but hope that one will be presented this fall.

Q. Do you see the risk of the island following the path of Greece?

As I already suggested, I believe that we are in a better condition than others. Observing the damage arising from the procrastination in taking action to put the fiscal finances back on to a solid footing and the pain that this can cause to the people of the country, which is what we are observing in Greece, is something that I trust would help our government and our parliament in taking the corrective action promptly.

Q. On projections of the economy are you concerned at a double dip?

The recovery in Cyprus, as in the euro area, is uneven. We do have some encouraging signs, but not all signs we see are encouraging. Our baseline scenario is that we will have some increase in GDP in the second half of the year. However, growth is not projected to be very high and I am concerned that we will continue to see an increase in unemployment for somewhat longer before the recovery is more solid.

I must say that in the current circumstances I view public confidence as an important factor in the prospects for a sustained recovery in Cyprus and an important factor in the coming months about public confidence will be the success that our government will have in implementing a comprehensive fiscal consolidation plan that promotes longer-term growth.