PARIS (MNI) – The following is the first part of a prepared text
delivered by European Central Bank Vice President Vitor Constancio in
his presentation of the ECB’s Annual Report 2010 to the Economic and
Monetary Affairs Committee of the European Parliament:

It is a great pleasure to present to you the European Central
Bank’s Annual Report for 2010 which forms a core part of our
accountability towards the European Parliament. It is the first time for
me to appear before your Committee in my capacity as the Vice-President
of the ECB and I am looking forward to an enriching exchange of views.

I will first briefly review the economic and monetary developments
over the past year, explain our monetary policy decisions, and summarise
our current assessment of the macroeconomic outlook. I ask for your
understanding that my remarks on the outlook should not be construed as
providing indications on the prospective monetary policy stance, as we
are in the so-called purdah period, where the members of the Governing
Council refrain from comments on the current outlook for monetary
policy.

I will also briefly touch upon the current fiscal challenges in the
euro area and issues related to financial stability and regulation.
Before concluding, I would like to address the EU economic governance
framework, following in particular the reports adopted by this Committee
and the start of the trialogue discussions.

Economic and monetary developments and outlook Monetary policy in
2010 and in early 2011 continued to operate in a very complex and
challenging environment. Renewed tensions in some financial market
segments in May 2010 posed new challenges for the conduct of monetary
policy.

Since early 2010, the economic recovery in the euro area has gained
momentum. This has been mainly driven by continued strong external
demand. At the same time, domestic demand strengthened during the review
period. Overall, following the 4.1% decline in 2009, euro area real GDP
increased by 1.8% in 2010. This outcome was much more favourable than
expected one year ago.

Looking forward, we expect the euro area economy to further benefit
from the ongoing recovery in the world economy. At the same time,
private sector domestic demand should increasingly contribute to
economic growth, benefiting from the accommodative monetary policy
stance and the measures adopted to improve the functioning of the
financial system. The Governing Council assesses the risks to this
outlook to be broadly balanced in a context of elevated uncertainty.

As regards price developments in the euro area, inflation has been
on an upward trend since early 2010, mainly reflecting rises in global
commodity prices. The average annual inflation rate rose to 1.6% in
2010, and continued increasing in early 2011, reaching 2.7% in March and
according to Eurostat flash estimate 2.8% in April.

While domestic price pressures are still moderate, risks to the
inflation outlook have moved to the upside. These relate mainly to
higher than expected energy prices. In addition, increases in indirect
taxes and administered prices may be greater than expected, owing to the
need for fiscal consolidation in the coming years.

Finally, the ongoing recovery in economic activity could result in
stronger than expected domestic price pressures. While our monetary
analysis indicates that the underlying pace of monetary expansion is
still moderate and money based medium term forecasts show inflation
subdued, monetary liquidity may facilitate the accommodation of price
pressures stemming from other factors.

Under these conditions, the Governing Council of the ECB, at its
meeting of 7 April 2011, decided to increase the key ECB interest rates
by 25 basis points, after maintaining them unchanged for almost two
years at historically low levels. This step was warranted to adjust the
very accommodative monetary policy stance in the light of upside risks
to price stability.

Indeed, it is essential that recent price developments do not give
rise to broad-based inflationary pressures over the medium term through
second round effects. Our decision to raise rates will contribute to
keeping inflation expectations in the euro area firmly anchored in line
with the Governing Council’s aim of maintaining inflation rates below
but close to 2%, over the medium term. Such anchoring is a prerequisite
for monetary policy to contribute to economic growth. Historically,
interest rates remain low across the maturity spectrum. Thus, our
current monetary policy stance remains accommodative, supporting
economic activity and job creation.

In view of the ongoing financial tensions, the ECB kept several of
its non-standard monetary policy measures in place in 2010 and early
2011, notably the full allotment of liquidity at a fixed interest rate
in most refinancing operations. In addition, in May 2010, the ECB
decided to launch the Securities Markets Programme, enabling the
Eurosystem to purchase private and government bonds, with the aim of
supporting the transmission of monetary policy.

Liquidity effects stemming from these purchases have been fully
neutralised by liquidity-absorbing operations. All the non-standard
measures taken during the period of acute financial tensions are, by
construction, temporary in nature and will be adjusted when appropriate.

Fiscal policies and bond markets Turning to fiscal policies, fiscal
deficit and debt ratios had deteriorated substantially in 2008 and 2009.
In 2010 the euro area deficit to GDP ratio only broadly stabilised at a
very high level, while the debt ratio continued to increase. Individual
countries experienced extremely high deficit rates.

Taking a broader view, the economic recession amplified imbalances
in fiscal policies that had built up gradually long before the crisis.
In particular, many countries failed to implement sound fiscal policies
during good economic times. Temporary revenue windfalls were used to
finance permanent expenditure increases and some countries failed to
achieve structurally sound fiscal positions despite a long period of
strong economic growth. On the institutional side, the EU fiscal
framework (which had been revised in 2005) was too weak and not
implemented with sufficient rigour.

Reflecting large fiscal imbalances and a loss of investor
confidence, government bond spreads increased drastically for some euro
area countries and became very volatile in 2010. The willingness of
investors to support government financing needs declined. Greece and
Ireland in 2010 required financial support by means of joint EU/IMF
programs. Portugal also asked for assistance in April.

Looking ahead it is essential that these three countries undertake
drastic reforms. Greece and Ireland have to fully implement the agreed
programmes and for Portugal the approval of a convincing adjustment
programme is now of the essence.

[TOPICS: M$$EC$,M$X$$$,MT$$$$,MGX$$$,M$$CR$]