BANK OF GREECE MONETARY POLICY

Transcription

1 BANK OF GREECE MONETARY POLICY ÌÁRCH 2001

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3 BANK OF GREECE 21, E. Venizelos Avenue GR Athens Economic Research Department - Secretariat Tel Fax Printed in Athens, Greece at the Bank of Greece Printing Works ISSN

4 BANK OF GREECE REPORT ON MONETARY POLICY MARCH 2001

5 To the Greek Parliament and the Council of Ministers This Report on Monetary Policy is submitted to the Greek Parliament and the Council of Ministers in accordance with the Statute of the Bank of Greece. It is the last report on the monetary policy pursued as the exclusive responsibility of the Bank of Greece. It is also the first report after the introduction of the euro and the implementation of the single European monetary policy in Greece since the start of The first three chapters examine developments in the markets for money, foreign exchange, bank credit and capital. The course of inflation, economic activity, employment and the balance of payments in 2000 are also examined and conclusions are drawn regarding the contribution of monetary policy to the attainment of a high level of price stability and to the entry of Greece into the euro area. Monetary policy was conducted in a particularly adverse environment in 2000, considering the inflationary pressures caused by the steep rise in international oil prices and the appreciation of the US dollar through to November. Meanwhile, interest rate policy was subject to restrictions, as Bank of Greece interest rates had to be aligned with the lower rates of the European Central Bank and the exchange rate of the drachma had to converge on its conversion rate against the euro. Nevertheless, monetary policy achieved its main objectives. First, it contributed decisively to meeting the convergence criteria for inflation, as well as the criteria for the exchange rate and long-term interest rates. Second, through a cautious and gradual lowering of interest rates, monetary policy alleviated inflationary pressures, at a time when core inflation was adversely affected by special factors and by the indirect impact of exogenous factors on prices. Third, through Bank of Greece interventions in the foreign exchange and money markets, monetary policy contributed to the smooth and gradual convergence of the drachma s current exchange rate on its conversion rate against the euro. Several institutional, operational and technical adjustments had to be carried out before Greece could qualify for euro area membership, in order to enable the introduction of the euro in bookentry form and the participation of the Bank of Greece in the Eurosystem. These adjustments are described in Chapter IV. The single monetary policy, which is now also conducted in Greece, aims to secure price stability in the euro area, an essential condition for rapid and sustainable economic growth. In the present conjuncture, the single monetary policy seeks to ensure that the expectations of economic agents remain focused on price stability, so that euro area inflation can again fall below 2% this year. The objectives, strategy and orientations of this policy for 2001 are presented in Chapter V. Greece s entry into Economic and Monetary Union will undoubtedly contribute to securing a high degree of price stability and rapid economic growth in the long run. However, Greece cannot rely on the single monetary policy alone to consolidate conditions of price stability, as this policy aims to achieve low inflation in the euro area as a whole, and not in individual countries. National economic policy must therefore play a more active role, so as to offset unexpected adverse effects exogenous or endogenous on inflation and, at the same time, seek to create the prerequisites for a steadily high rate of economic growth. 4 MONETARY POLICY

6 A return to the conditions of monetary stability achieved in 1999 and in early 2000 is a top priority. It is estimated that basic determinants of inflation in Greece will have an on the whole favourable influence in The annual rate of inflation is gradually expected to fall below 3% during the second half of 2001 and, given certain assumptions and prerequisites, to converge on a rate compatible with price stability. These assumptions and prerequisites are detailed in Chapters VI and VII. Nonetheless, there are some elements of uncertainty, such as the exact impact of the change in monetary conditions, the rate of increase in unit labour costs, and the fluctuation of oil prices, all of which could have an adverse effect on the course of inflation. These uncertainties call for vigilance and entail certain implications regarding the conduct of national economic policy and the behaviour of the social partners, as detailed in Chapter VII. Following Greece s entry into the euro area, a continuous and substantial improvement in productivity and competitiveness, within a reasonable length of time, is essential if real economic convergence combined with price stability is to be achieved. National economic and structural policies and the behaviour of the social partners must be oriented towards securing this prerequisite. Furthermore, as the means for the conduct of national monetary policy have been lost along with the flexibility characterising their uses, the scope of macroeconomic policy for dealing effectively with the influence exerted on national income and inflation by exogenous shocks or unexpected changes in domestic economic conditions must be broadened. Athens, March 2001 Lucas Papademos Governor MONETARY POLICY

7 Monetary Policy Council of the Bank of Greece Chairman Lucas D. Papademos Members Panayotis A. Thomopoulos Nicholas C. Garganas Vassilis S. Droucopoulos Antonis G. Mantzavinos Nicholas D. Paleocrassas 6 MONETARY POLICY

8 Contents I. Monetary policy objectives and accomplishments in II. Monetary developments and policy in International economic developments The foreign exchange market in Greece Interest rates and money market interventions Monetary aggregates Credit expansion Capital markets 37 III. Inflation and economic activity 1. Price developments Determinants of inflation Economic activity and employment Balance on external transactions 61 IV. Adjustments for the introduction of the single currency 67 V. The single monetary policy in VI. Inflation prospects in Greece 81 VII. Conclusions 87 Monetary policy measures 93 Glossary 97 Statistical appendix 99 MONETARY POLICY

9 Charts 1 Exchange rate of the euro against the US dollar and the Japanese yen 16 2 Exchange rate of the drachma against the euro 19 3 Deviation of the drachma from its central rate against the euro, in percentages 20 4 Bank of Greece interventions in the foreign exchange market 21 5 Exchange rate of the drachma against the US dollar and the Japanese yen 21 6 Effective exchange rate of the drachma 22 7 Bank of Greece interest rates and interbank overnight rate 22 8 Bank of Greece intervention rate on 14-day operations and ECB main refinancing rate 23 9 Bank of Greece interventions in the interbank market Three- and twelve-month ATHIBOR rates Yield curves in the Athens interbank market (ATHIBOR) 25 12a Three-month interbank rates in Greece and the euro area 26 12b Three-month interbank rate differential between Greece and the euro area Bank deposit rates Bank lending rates Bank lending rate differentials between Greece and the euro area Term structure of Greek government bond yields Yield differential between the 10-year Greek government bond and the 10-year comparable German bond Liquidity indicator M4N Athens Stock Exchange (ASE): composite share price index and value of transactions Consumer price index and core inflation Harmonised index of consumer prices in Greece, the EU and the euro area Goods and services included in core inflation Import price index and the inverse of the effective exchange rate of the drachma Evolution of CPI and WPI fuel prices and of the average drachma price of Brent crude oil Wholesale price index Impact of the fuel price increase on inflation Output and business expectations in manufacturing 56 A. Indices B. Percentage change over same month of previous year 28 Consumer demand 58 A. Retail sales volume and business expectations B. New passenger car registrations 29 Total unemployment rate Business forecasts on employment 60 8 MONETARY POLICY

10 31 Employment M3 rate of change in the euro area Government securities yield curve in the euro area Inflationary expectations of consumers and business firms 86 Tables I Adjustments of Bank of Greece interest rates 23 II Deposit and lending rates and inflation 27 IIπ Yield differentials between various 10-year government bonds and the corresponding German bond 30 IV Monetary aggregates 31 V Total credit expansion 33 Vπ Central government net borrowing requirement 34 VII Private sector financing 35 XIII Export price index and effective exchange rate of the drachma 52 XIV Cuts in indirect taxes and telephone call rates: impact on inflation 54 XV Employees earnings, productivity and labour costs 54 XVI Demand and gross domestic product 55 XVIπ Indicators of consumer demand 57 XVπππ Indicators of investment demand 59 Xπà Breakdown of Greece s external trade 62. Exports (excluding fuel) by geographical area of destination µ. Imports (excluding fuel) by geographical area of origin Xà Breakdown of import bill increase (excluding oil) in euro, by product category: XÃπ Monetary Policy Council (MPC) Acts in 2000 for the harmonisation of the monetary policy framework with that of the Eurosystem 68 VIII Consumer financing 36 IX Fund-raising through the Athens Stock Exchange 39 XÃππ Comparison of forecasts on real GDP growth rate 75 X XI XII Harmonised index of consumer prices: Greece and the EU 43 CPI goods and services by descending 12-month rate of change in December Evolution of real estate (dwellings) prices 49 Box 1 The entry of the Bank of Greece into the Eurosystem and the conduct of the single monetary policy 75 MONETARY POLICY

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12 I. Monetary policy objectives and accomplishments in 2000 The main objective of monetary policy in 2000 was to secure a high degree of price stability. In the first half of the year, pending the decision to admit Greece into the euro area (June 2000), monetary policy focused on meeting the convergence criteria related to inflation, exchange rate stability and long-term interest rates. In the second half, monetary policy had, first, to contain mounting inflationary pressures due to the steep rise in international oil prices and the continuing appreciation of the US dollar and, secondly, to ensure a smooth changeover to the single currency. The changeover restrained monetary policy conduct, as it entailed the convergence of Greek interest rates on the lower euro area rates, as well as of the current exchange rate of the drachma on its conversion rate to the euro. The average annual rate of price increases on the basis of the Harmonised Index of Consumer Prices (HICP) remained at 2%-2.1% up to end- June A high degree of price stability was therefore maintained during the first half of the year. Specifically, the HICP stood at 2% in March 2000, thereby enabling Greece to meet the inflation-related convergence criterion. However, inflationary pressures due to the rise in oil prices and the appreciation of the US dollar against the euro continued. As a result, the average annual rate of inflation on the basis of the HICP accelerated from 2.2% in July to 2.9% in December (the annual rate of increase in the HICP was 3.7% in December). The annual rate of inflation on the basis of the national Consumer Price Index (CPI) ranged between 2.5% and 3.1% until June, rose to 4.2% in November and fell slightly to 3.9% in December. These developments during 2000 mainly reflect the impact of the two exogenous factors mentioned above. Core inflation, on the other hand, which is not directly affected by oil MONETARY POLICY

13 price increases, 1 initially followed a downward trend, remaining below 2% through August However, it began to increase from September onwards, reaching 3.4% in December. The containment of core inflation at low levels until August was mainly due to the anti-inflationary policy conducted in recent years (the effects of which usually manifest themselves on prices with a time lag) and the reduction in the general government deficit as a proportion of GDP, the relative stability of the growth rate of unit labour costs in the business sector and stiffer competition in the telecommunications industry. The rise in core inflation from September onwards was due to the elimination of the beneficial effect on prices from cuts in some indirect taxes in 1999 and to the indirect impact of the increase in the prices of oil and imported raw materials on the prices of domestic goods and services. It was also due to the direct impact that the appreciation of the US dollar against the euro and, to a lesser extent, the depreciation of the drachma against the euro had on the prices of imported consumer goods. At average levels, however, the growth rate of core inflation fell to 2% in 2000, from 2.9% in The convergence of the drachma s exchange rate on its central exchange rate was completed smoothly in The drachma remained above its central rate throughout the year and converged on it gradually. On the whole, the drachma depreciated 3.1% against the euro in the course of The extent of the adjustment of the drachma s exchange rate against the euro was limited by the 3.5% rise in the drachma s central rate on 17 January This appreciation served to alleviate inflationary pressures, which would have been stronger had the central exchange rate remained unchanged. The foreign exchange market came under pressure from January through May 2000, partly as a result of uncertainties regarding Greece s ability to meet the inflation criterion and the final drachma/euro conversion rate. The Bank of Greece was able to deal with these pressures by intervening in the foreign exchange market and conducting a moderate interest rate policy. The decision of the Council of Ministers of National Economy and Finance (ECOFIN) on 19 June 2000 to admit Greece to the euro area and to set the conversion rate as the central exchange rate of the drachma against the euro helped stabilise expectations and normalise conditions in the foreign exchange market. In some cases the Bank of Greece sold foreign exchange in the following months, so as to lower the rate at which the exchange rate of the drachma was converging and to reduce its fluctuations. The divergence of the current exchange rate of the drachma from its central exchange rate gradually dropped to zero by mid-december Bank of Greece interest rates converged slowly on corresponding Eurosystem rates 2 during the second half of 2000, though especially in the last quarter. The policy of gradual interest rate cuts helped to reduce inflationary pressures and establish normal conditions in the foreign exchange market, thereby facilitating the gradual adjustment of the current exchange rate of the drachma to its central rate. The key interest rates of the Bank of Greece were lowered eight times during the year and were fully aligned with the rates of the European Central Bank (ECB) by 27 December. Specifically, the interbank money market intervention rate for 14-day operations was lowered by 600 basis points to 4.75%. The convergence of 1 Core inflation is measured by the annual rate of change in the CPI, excluding fuel and fresh fruit and vegetables. 2 The Eurosystem consists of the ECB and the national central banks of the Member-States of the European Union, which have adopted the euro (see Glossary). 12 MONETARY POLICY

14 Bank of Greece interest rates was facilitated by the rise in ECB rates by 175 basis points over the same period. Bank rates followed the same trend as Bank of Greece rates, albeit with a time lag: deposit rates were lowered during the year, but less than lending rates. Consequently, the interest rate spread decreased slightly between the beginning and the end of the year. The liquidity indicator M4N rose by 10.4% during 2000, compared with 5.5% in The twelvemonth rate of increase in M4N began accelerating in April and remained until the year-end above the range of 5%-7% forecast for the whole year. This acceleration mainly reflects capital shifts towards assets included in M4N, e.g. repos, which offered comparatively high yields. These developments are linked with conditions in the stock market and reduced the demand for equity-type mutual fund units, which are excluded from M4N. The faster rise in M4N also reflects increased demand for liquid assets, which was due to higher GDP growth in 2000 compared both with initial forecasts and with To a significant extent, however, the high rate of increase in M4N was largely due to special factors, such as its low level in 1999 and the relatively large increase in outstanding balances of foreign exchange deposits in drachma terms, owing to the appreciation of the US dollar and the depreciation of the drachme against the euro. Finally, liquidity supply was affected favourably by the acceleration of credit expansion and negatively by foreign transactions. Total credit expansion accelerated from 12.2% in 1999 to 20.2% in The acceleration basically reflects the rapid increase in bank credit to the private sector (2000: 28.5%, 1999: 14.2%), while credit expansion to the public sector in 2000 also exceeded 1999 levels (2000:16.1%, 1999: 11.3%). Faster credit expansion to the private sector was associated with the expiry at the end of March 2000 of the measures taken by the Bank of Greece to restrict bank credit, as well as with the significant cut in lending rates and faster GDP growth in Monetary policy was pursued in a particularly unfavourable environment in 2000, as it had to address inflationary pressures caused by the substantial rise in international oil prices and the appreciation of the US dollar through November. Meanwhile, the conduct of interest rate policy was subject to restrictions, as Bank of Greece interest rates had to be adjusted to the lower rates of the European Central Bank and the exchange rate of the drachma had to converge on the drachma/euro conversion rate. Monetary policy nevertheless achieved its primary objectives: first, it played a major role in helping Greece meet the convergence criteria related to inflation, the exchange rate and long-term interest rates; second, through a cautious and gradual reduction in interest rates, it alleviated domestic inflationary pressures, at a time when core inflation was adversely affected by special factors and the indirect impact of exogenous factors on prices; third, with Bank of Greece interventions in the foreign exchange and money markets, monetary policy contributed to the smooth and gradual convergence of the current exchange rate of the drachma on the drachma/euro conversion rate. It can thus be concluded that monetary policy made a decisive contribution in securing the prerequisites for Greece s entry into the euro area and served to shape favourable conditions for a smooth changeover to the single currency. MONETARY POLICY

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16 II. Monetary developments and policy in International economic developments The world GDP growth rate is estimated to have been 4.7% in 2000, 1 i.e. considerably higher than in 1999 (3.3%). Specifically, in 2000 it came to 4.3% in the OECD Member-States, compared with 3% in 1999, while in the European Union it stood at lower levels (2000: 3.3%, 1999: 2.5%). 2 However, since mid-2000 economic growth has been decelerating in the USA and certain European countries, owing to the rise in oil prices which led to increased consumer prices and reduced households disposable income, thus reinforcing the effects of the restrictive monetary policy applied in these countries since mid According to provisional estimates, the euro area GDP growth rate accelerated to 3.4% in 2000, from 2.5% in Concerning the components of GDP, the growth rate of private consumption is estimated to have declined slightly to 2.6% in 2000, from 2.8% in The path of private consumption embodies the favourable effects of the increase in the value of households assets in certain Member States, but was mainly determined by the development of real disposable income, which was adversely affected by the rise in oil prices. The increase in public consumption is estimated to have been 1.6% in 2000, i.e. the same as in 1999, while the growth rate of investment, which was relatively high in 1999 (5.3%), must have slowed down slightly in 2000 (4.6%). 4 In addition, it is estimated that exports grew rapidly 1 OECD estimates, Economic Outlook, December Announcement by the Statistical Service of the European Communities (Eurostat) on 8 March See footnote 2. 4 An increase was recorded, mainly in business investment. The growth of house construction is estimated to have decelerated in According to the European Commission, these contrasting developments are attributed both to the decline in real labour costs and to households excessive indebtedness, in conjunction with the rise in borrowing costs. MONETARY POLICY

17 in 2000 (11.7%, from 4.7% in 1999), reflecting the improved competitiveness in the euro area owing to the weakening of the euro, as well as the increased volume of world trade (13.3% in 2000) as a result of the recovery of the world economy. Imports in the euro area are estimated to have grown by 10.4% in 2000, against 6.7% in On the supply side, the main contributors to GDP growth in 2000 in the euro area were the industrial sector and certain subsectors of services. The euro area inflation, based on harmonised consumer price indices, rose to 2.3% in 2000, from 1.1% in 1999, owing to the increase in energy prices, which, according to ECB estimates, added approximately 1.25 percentage points to the growth rate of prices. The overall fiscal position (at general government level) of the euro area countries 5 is estimated to have shifted to a surplus of 0.3% of GDP in 2000, from a deficit of 1.3% in 1999, owing to the sale of UMTS licences. If the revenues from the sale of these licences are excluded, the average fiscal deficit of the euro area is estimated at 0.8% of GDP in Public revenues as a percentage of GDP remained at high levels (2000: 47.6%, 1999: 47.8%) owing to the substantial economic growth in the euro area and in spite of the tax cuts in many countries. The general government expenditure is estimated to have declined as a percentage of GDP (2000: 47.3%, 1999: 49.1%), mainly owing to reduced unemployment and interest payments. However, the structural primary surplus, 6 as a percentage of GDP on average, excluding revenue from the sale of UMTS licences, is estimated to have stood close to the level of 1999 (3.5%). The public debt/gdp ratio is estimated to have declined to 69.8% in 2000, from 72.1% in As regards developments in money markets, since the beginning of 2000 the ECB has raised its key interest rates six times; as a result, the rate in the main refinancing operations rose by 175 basis 5 European Commission Forecasts, autumn Euro area forecasts do not include Greece. 6 The structural primary fiscal deficit or surplus is defined as the respective deficit or surplus excluding interest, calculated on the basis of the assumption that GDP stands at its potential level (i.e. the full employment level). This index enables a better assessment of the fiscal policy stance, since the observed fiscal deficit or surplus is affected by the business cycle through the operation of automatic stabilisers. 16 MONETARY POLICY

18 points in total and stood at 4.75% after the last increase on 6 October These increases were due to heightened monetary and credit expansion, the relatively extended period of depreciation of the euro and the substantial increases in oil prices, all of which boosted, in a period of strong economic growth, inflationary pressures in the medium term. However, taking into account monetary and economic developments in the euro area since October, the ECB noted that risks to price stability had moderated and it did not change its interest rates further. During the first half of 2000,the annual growth rate of M3 broadly remained at high levels, much higher than the reference value (4.5%), reaching a peak of 6.7% in April. However, in the last few months of 2000 it slowed down, to 4.9% in December, from 5.7% in August. Total credit expansion slackened and its average annual rate fell to 7.4% in 2000, from 8.4% in This development is attributed to the deceleration of credit expansion to the general governments of the euro area countries (average rate in 2000: 1.3%, 1999: 2.9%), while the average annual growth rate of credit to the private sector remained at the 1999 level (10.5%). Specifically, credit expansion to the private sector varied between 9.4% and 11.4% during 2000; however, towards the end of the year it slowed down to 10.3% in December, from 10.9% in September. In line with the rise in ECB interest rates, the three-month EURIBOR increased from 3% on average in 1999 to 4.4% in 2000, reaching 4.9% by the end of the year. In spite of the rise in short-term interest rates, the yields of long-term securities in the euro area remained constant (around 5.5%) during 2000 and from November onwards they dropped somewhat and stood at levels slightly higher than 5% at the end of the year. This development underlines, inter alia, the credibility of monetary policy. The exchange rate of the euro followed a downward course until September, compared with the other major currencies (see Chart 1), mainly because of the different US and euro area growth rates, as well as the substantial capital inflows for direct investment in the USA, although the depreciation of the euro seems to be at levels higher than would be justified by the differences in main economic aggregates. To reverse this downward path of the euro, especially against the US dollar, the ECB intervened in the foreign exchange market both in coordination with the monetary authorities of the USA, Japan, the UK and Canada, and independently (22 September and beginning of November 2000 respectively). Given also the market sentiment that the USA and euro area growth rates are converging, the euro started to strengthen against the US dollar from 28 November 2000 onwards and, by the end of the year, it had appreciated by 9.9%. It is estimated that the US output growth rate remained at high levels (2000: 5%, 1999: 4.2%) 7 because the adoption of new technologies in computers and telecommunications boosted the economy. However, it should be noted that the GDP growth rate began to slow down over the second half of The GDP annual growth rate fell to 3.4% in the fourth quarter of 2000, from 6.1% in the second quarter, and is expected to stand between 2% and 2.5% in Pressures on the labour market were limited and led to a slight pick up of the growth rate of compensation per employee in the private sector (2000: 4.5%, 1999: 4.3%). This development, in conjunction with the substantial cyclical growth of productivity in the private sector (2000: 3.8%, 1999: 2.6%), led to a major slowdown of the growth rate of unit labour costs in the private sector (2000: 0.7%, 7 According to the latest data. MONETARY POLICY

19 1999: 1.6%). However, owing to the rise in oil prices and in spite of the appreciation of the US dollar against the other major currencies, CPI inflation in the USA rose to 3.4% in 2000, from 2.2% in The US fiscal surplus is estimated to have increased, in spite of the rise in public expenditure, to 2.3% of GDP in 2000, from 1% in 1999, mainly owing to increased revenues from the taxation of business profits. The US current account deficit as a percentage of GDP rose further to 4.3% in 2000, from 3.6% in 1999, because of the substantial growth of imports, associated with the acceleration of the average economic growth rate in 2000, the appreciation of the US dollar and the rise in oil prices. The US Federal Reserve System raised interest rates three times, by a total of 100 basis points. On 16 May 2000 the rate for overnight deposits on the money market stood at 6.5% and remained unchanged until the end of the year. The average increase in the three-month interbank rate was 6.5% in 2000, from 5.4% in By contrast, long-term interest rates fell substantially in the course of Specifically, the 10-year bond yield fell by approximately 110 basis points, from 6.3% in December 1999 to 5.2% in December 2000, owing to expectations of an economic slowdown in the USA. The annual growth rate of M2 recorded minor fluctuations in the course of 2000 but, on average, stood at lower levels than in 1999 (2000: 5.7%, 1999: 7.4%), 8 indicating that monetary policy became more restrictive in In Japan, the GDP growth rate is estimated to have picked up to 1.5% in 2000, from 0.2% in 1999, 9 mainly owing to business investment activity. In spite of the increase in real GDP, nominal GDP remained unchanged because of the drop in the deflator (2000: 1.5%, 1999: 0.9%). The rate of change in CPI prices was negative in 2000 ( 0.6%), as well as in 1999 ( 0.3%), in spite of the rise in oil prices, because the profit margins of oil distribution companies were restricted by structural reforms. Fiscal policy, mainly associated with increased investment expenditure to support economic activity, is estimated to have led to a fiscal deficit of 6% of GDP in 2000, compared with 7% in In August 2000 the central bank of Japan introduced a 0.25% interest rate for overnight deposits in the interbank market, which were previously interest-free. The three-month interbank rate recorded a slight increase in the second half of 2000 and stood at 0.6% in December, from 0.1% in June. The 10-year bond yields remained virtually unchanged, at 1.8% on average in Bond yields increased slightly in August and September, because the central bank of Japan abandoned its zero interest rate policy. In spite of this small pickup in interest rates and the slowdown in the growth rate of money, 10 monetary and credit conditions remained favourable for investment and growth in Japan, given that the financial restructuring of enterprises improved cash flows and limited the demand for bank loans. 2. The foreign exchange market in Greece The policy objective in the foreign exchange market in 2000 was the relative stability of the exchange rate of the drachma against the euro, which was the intermediate target of monetary policy. The benchmark was the central exchange 8 See ECB, Monthly Bulletin, February OECD estimates, Economic Outlook, December The average annual growth rate of M2 in Japan fell to 2.1% in 2000, from 3.7% in See ECB, Monthly Bulletin, February MONETARY POLICY

20 rate of the drachma in Exchange Rate Mechanism II 11 (ERM II). Developments in the foreign exchange market in 2000 were characterised by the fact that the exchange rate of the drachma remained above the drachma s central rate throughout the year and that it converged to this rate gradually and smoothly. As from 1 January 2001, the central exchange rate of the drachma ( drachmas/euro) is the irrevocable rate of conversion of drachmas into euro, as determined by the ECOFIN Council resolution of 19 June The convergence of the drachma towards its central exchange rate was supported by the interest rate policy and interventions of the Bank of Greece in the foreign exchange market. The drachma recorded an overall decline of 3.1% against the euro in On 17 January 2000 its central exchange rate was raised by 3.5% (from to drachmas/euro), which facilitated the anti-inflationary monetary policy-making. Indeed, this appreciation restricted the extent of adjustment of the current exchange rate and, therefore, the inflationary pressures that would have been exerted had the central exchange rate remained unchanged. Specifically, the appreciation of the central exchange rate contributed to holding down imported inflation and favourably affected inflationary expectations and the moderation of wage increases agreed in the framework of the two-year National General Collective Labour Agreement signed in May The deviation of the drachma from its central exchange rate (from 6.5% at end-1999 to 2.9% on 17 January 2000), mainly owing to the change in the central exchange rate, was gradually contained in the course of 2000 and nullified in mid- December (see Charts 2 and 3). In the first five months of 2000 occasional pressures were exerted in the foreign exchange market, associated with increased payments for trade transactions, as well as capital outflows owing to market uncertainty about Greece s timely fulfilment of the infla- 11 It should be recalled that the drachma was included in the Exchange Rate Mechanism (ERM) of the European Monetary System in March 1998 at a central exchange rate of 357 drachmas per ECU and a standard fluctuation band of ±15%. From the beginning of 1999 until Greece s entry into the euro area, the drachma took part in ERM II (which replaced the previous mechanism) with a central exchange rate set, for technical reasons, at drachmas per euro and the same fluctuation band. On 17 January 2000 the central exchange rate of the drachma against the euro was raised by 3.5% to drachmas per euro. According to the ECOFIN resolution of 19 June 2000, this became the irrevocable rate of conversion of drachmas into euros applicable since 1 January MONETARY POLICY

21 tion criterion and about the level of the rate of conversion of drachmas into euro, as well as to the developments in the Athens Stock Exchange (ASE). The resolution made by the ECOFIN Council on 19 June 2000 that Greece meets the requirements for entry into the single currency area and that the rate of conversion of drachmas into euro will be its central exchange rate in ERM II stabilised expectations about the path of the exchange rate 12 and contributed to the creation of smoother conditions in the foreign exchange market. The Bank of Greece intervened in the foreign exchange market in the course of 2000, first to slow down the convergence of the exchange rate of the drachma towards its central exchange rate and, second, to moderate its fluctuations. In 2000 as a whole, the interventions of the Bank of Greece for the sale of foreign currency amounted to US$ 9.8 billion, while those for the purchase of foreign currency totalled US$ 1.3 billion. The sale of foreign currency was largely connected with capital outflows that were due to interest rate and the drachma exchange rate convergence as well as with conditions in the ASE. It should be noted that in the last two years, especially after the entry of the drachma into the ERM, the Bank of Greece made more extensive interventions for the purchase of foreign currency (see Chart 4), since the anti-inflationary monetary policy of high interest rates had attracted substantial amounts of foreign capital that exerted upward pressure on the exchange rate. The exchange rate of the drachma against currencies other than the euro was in line with the development of the exchange rate of the euro against such currencies, given that the drachma exchange rate policy aimed, as in the previous year, at the relative stability of the exchange rate of the Greek currency against the euro. Specifically, the drachma depreciated against the US dollar, from drachmas/dollar at end-1999 to drachmas/dollar at end-november However, in December indications of an economic slowdown in the USA contributed to the recovery of the euro against the US dollar and, therefore, to reinforcing 12 It should be noted that, while until 19 June 2000, i.e. when the ECOFIN made its resolution determining that the drachma would be converted into euro on 1 January 2001 at its central exchange rate, the deferred value of euro for contracts maturing at end- December 2000 implied that the rate of conversion of drachmas into euro was depreciated compared with the drachma s central exchange rate, after that date and until the end of 2000 such deferred value broadly implied that the rate of conversion of drachmas into euro was equal to the drachhma s central exchange rate. 20 MONETARY POLICY

22 the exchange rate of the drachma against the US currency, which stood at drachmas/dollar at the end of As regards the Japanese yen, the drachma gradually fell from drachmas/100 yen at end-1999 to drachmas/100 yen at the beginning of November By the end of the year, however, the weakening of the yen against the euro, owing to the reemergence of concerns about the strength of economic growth in Japan and the problems encountered by the Japanese financial system, also resulted in the drachma strengthening against the yen, the exchange rate of which stood at drachmas/100 yen at end-2000 (see Chart 5). Overall, in the course of 2000 the exchange rate of the drachma fell by 10.2% against the US dollar and picked up by 1.1% against the Japanese yen. In effective exchange rate terms, 13 the drachma fell by 3.3% between end-1999 and end-2000, mainly owing to its depreciation against the dollar and the 13 The effective exchange rate is the value of a representative basket of foreign currencies, each of which is weighted according to its relative importance for Greece s external trade. MONETARY POLICY

23 euro in this period (see Chart 6). On average, the effective exchange rate fell by 6.2% in Interest rates and money market interventions The interest rate policy of the Bank of Greece The interest rate policy of the Bank of Greece in 2000 aimed both at limiting the exogenous pressures exerted on prices by the rise in oil prices and the strengthening of the dollar and at securing smooth conditions for the euro cash changeover. The unfavourable external environment complicated the conduct of interest-rate policy and dictated the slower decline of interest rates. In the course of 2000 and until mid-december, the Bank of Greece reduced its key interest rates eight times and on 27 December these rates were fully 22 MONETARY POLICY

24 Table I Adjustment of Bank of Greece interest rates (Percentages per annum) Date of interest rate change Overnight deposit rate 1 First tier Second tier 14-day intervention rate Lombard rate 27 Dec Jan March Apr June Sept Nov Nov Dec Dec The second tier of the deposit facility was abolished on 29 June Since then, the rate quoted in the first tier column applies to the unified deposit acceptance account. Source: Bank of Greece. aligned with the corresponding ECB rates 14 (see Chart 7). Overall, the money market intervention rate for 14-day operations was reduced by 6 percentage points to 4.75%, while the standing facilities rates of the Bank of Greece were reduced by approximately the same amount (see Table 1). The largest part of this interest rate adjustment took place in the second half of 2000, with over 40% occurring in the last two months of the year. It should be noted that the convergence of the interest rates of the Bank of Greece with those of the ECB was facilitated by the 1.75 percentage point increase in the ECB rates in 2000 (see Chart 8). In the course of 2000 there has been a fundamental change in money market conditions. From the beginning of the year until mid-may, excess liquidity continued in the market and, by its interventions, the Bank of Greece absorbed this liq- 14 See the chapter entitled Monetary policy measures. MONETARY POLICY

25 uidity (average daily outstanding balance of absorbed funds: 760 billion drachmas) in order to keep interest rates at levels compatible with antiinflationary policy. Since mid-may 2000, the interbank money market recorded a liquidity deficit, for the first time since the entry of the drachma into the ERM in March The interventions of the Bank of Greece in the market changed direction and the Bank began to support the liquidity of banks (see Chart 9), since the capital outflows in May, the widening current account deficit in the second half of the year and increased fund-raising by the State between May and November 15 reduced bank liquidity. In the second half of 2000, the Bank of Greece supported bank liquidity by an average daily amount of 625 billion drachmas. Interbank rates Interest rates in the interbank money market, which react with the shortest time lags compared with other rates to changes in Bank of Greece interest rates, have broadly followed the downward path of the latter. Specifically, after the revaluation of the central exchange rate of the drachma against the euro and the adjustment of the Bank s key interest rates in January 2000, the ATHIBOR declined by 0.6 to 1.2 percentage points, with the biggest decrease being noted in longer maturities. In the course of the following months until mid-november 2000, interest rates showed a slightly downward trend, which intensified towards the end of the year 16 (see Chart 10). Overall, in 2000 interbank interest rates dropped by 3.9 to 4.9 percentage points, with the biggest decline being recorded in shorter maturities. It should be noted that, until mid-november 2000, the decrease in interest rates for shorter maturities was subdued, reflecting delays in the adjustment of Bank of Greece rates. By contrast, the decline in interest rates for longer maturities (6 to 12 months) was steeper during this period, since their path also embodied expectations concerning their level after Greece s entry into the euro area (beginning of 2001), i.e. the period in which these interest rates 15 It should be noted that between May and November 2000 the reserves of the State with the Bank of Greece increased by 700 billion drachmas. 16 Since the end of 2000 the ATHIBOR reference rates are no longer compiled and have been replaced by the EURIBOR rates, which concern the entire euro area. For the calculation of the ATHIBOR, the prices of the 14 banks that participated in the market were taken into account. These banks were obliged to report prices (for the demand and supply of funds) for 1-, 2-, 3-, 6-, 9- and 12-month maturities. The bid-offer spread was 75 basis points and the minimum amount per operation was 1 billion drachmas. The ATHIBID and ATHIBOR rates were determined daily, from a.m, to noon, as the price averages reported by these banks after deducting the three highest and the three lowest bids. 24 MONETARY POLICY

26 would have converged towards the lowest level of the corresponding euro area rates. In the course of 2000 the interbank market yield curve shifted downwards. The yield curve remained virtually flat for most of the year for shorter maturities (up to 3 months) and slightly descending for longer maturities. However, as the date approached for Greece s entry into the single monetary policy area and as interest rates gradually converged with those of the euro area, the yield curve showed a decreasing trend for longer maturities and an increasing one for shorter maturities (see Chart 11). The shape and evolution of the yield curve are generally indicative of market expectations about the rate of adjustment of Bank of Greece rates. At the end of 2000, the yield curve was virtually flat and became largely identical with that of the euro area (EURIBOR). Specifically, its slope, as measured by the spread MONETARY POLICY

27 between 12-month and 1-month interest rates, was limited to 0.1 percentage point (from 1.2 percentage points at the end of 1999). The spread between Greek interbank interest rates and those of the euro area gradually narrowed in the course of 2000, at a faster pace towards the end of the year. The convergence of interest rates was also assisted by the rise in euro area interest rates by 0.9 to 1.8 percentage points, in which the biggest increase was noted for shorter maturities (see Charts 12a and 12b). 26 MONETARY POLICY

28 Table II Deposit and lending rates and inflation (Percentages per annum, period averages) Deposit rates Lending rates To business firms To households Period Savings deposits 12-month time deposits Short-term Long-term Consumer loans 1 Housing loans 2 Inflation rate Dec Jan Feb March April May June July Aug Sept Oct Nov Dec Average rate of all categories of consumer loans. 2 Average rate of floating-rate housing loans maturing in over 5 years. 3 Percentage change in the CPI over same month of previous year. Sources: Bank of Greece and National Statistical Service of Greece (NSSG). Bank deposit and lending rates Bank deposit and lending rates gradually declined in 2000, following the path of interbank market rates, although the decrease was generally smaller than that of interbank rates, with the exception of consumer loan rates where the decrease was bigger. It should be noted, however, that the adjustment of deposit and lending rates was slow, given that changes in the central bank s interest rates are transmitted to the market rates with a time lag. 17 Owing to the acceleration of inflation in the last five months of the year, real deposit and lending rates decreased more than nominal rates in Concerning the path of individual rates, the average savings and time deposit rates decreased by 3.4 to 4.1 percentage points in 2000 (see Table II and Chart 13). Lending rates also declined substantially, especially for consumer loans (see Table II and Chart 14). In spite of the fact that the decline in deposit and lending rates was not uniform in the course of 2000, overall lending rates decreased on average more than deposit rates and the spread between them became smaller in This was mainly due to increased competition in some segments of the bank market, such as consumer and housing credit. However, in adjusting their interest rates in December 2000 and January 2001, banks reduced deposit rates more than lending rates; as a result, the downward trend in the spread between these rates reversed in this period. The spreads between Greek and euro area deposit and lending rates were substantially reduced in 17 This is corroborated by the fact that several banks announced a reduction in their interest rates in January MONETARY POLICY

29 2000, given that euro area rates increased parallel to the decline of Greek ones (see Chart 15). The biggest interest rate spread at the end of 2000 (3.7 percentage points) concerned consumer loans and the smallest one (0.8 percentage point) fixed-rate housing loans with a maturity of over five years. Although long-term rates in general converge more, convergence accelerated recently for shortterm rates as well. In January 2001, Greek banks reduced their rates further and, for that reason, it is estimated that interest rate spreads with the other euro area countries have decreased. Any remaining spreads now reflect differences in credit risk, operating costs, portfolio structure and/or changes in bank products offered. Yields of government paper Yields of Greek government securities continued in 2000 to converge towards the lower yields of the corresponding euro area securities and convergence was faster in short maturities. 18 At the same time, 18 Unlike interbank interest rates, where convergence on euro area rates was full, some differences remain in the yields of government paper, which reflect credit risk. 28 MONETARY POLICY

30 Greek yields were affected by trends in euro area bond markets. Therefore, the yield curve of government securities 19 shifted downwards and by the end of 2000 it acquired the usual positive slope 20 throughout its length (the yield spread between the 20-year bond and the 12-month Treasury bill was 1.2 percentage points at the end of 2000), while in the first few months of the year the shorter end of the yield curve (up to 5 years) had a negative slope (see Chart 16), reflecting the high short-term rates required by the anti-inflationary character of monetary policy. It should be noted that the three-year bond yield declined by 2 percentage points between end-1999 and end-2000 and the 10-year bond yield by one percentage point. 19 Not including three- and six-month Treasury bill yields. As from August 1999, three- and six-month Treasury bills are issued every three months and, for this reason, statistics on yields in these maturities are incomplete. 20 In the event that markets do not anticipate any change in short-term interest rates, the yield curve has a positive slope, reflecting the fact that longer-term securities have a higher interest rate, because it incorporates a liquidity premium. MONETARY POLICY