Verbal discipline is crucial for the orderly functioning of currency markets, European Central Bank President Jean-Claude Trichet told CNBC Europe in an exclusive interview, a veiled plea to French President Nicolas Sarkozy and other European officials to support the ECB's policies.
More and more euro zone politicians and business representatives have stepped up pressure on the ECB to follow in the Federal Reserve's footsteps and cut rates to rein in a fast appreciation of the euro, which they say is hurting exports.
"We are in a universe when you can say anything when you are not in a position of responsibility, but when you are in a position of responsibility, it's very important to apply verbal discipline," Trichet said.
Stock market players have been expecting the Federal Reserve to cut rates further at its next meeting at the end of October, but that prospect looks increasingly unlikely as the U.S. economy seems to have weathered the housing crisis.
"We will see what happens," Trichet said when asked on the chances of a US recession.
"I have always trusted the Federal Reserve's diagnosis, which is not concluding in that direction, and I have always until now been right in trusting friends in the Federal Reserve System," he added.
The ECB risks falling out of sync with the Fed if the US monetary authority cuts rates again. With inflationary pressures building up, the ECB still needs to raise rates, but this would push the euro even firmer against the dollar.
Some analysts have said the euro could rise as high as $1.45 to the dollar by the end of this year.
Fighting Price Rises Key to Growth
Fighting inflation is paramount for ensuring solid economic growth and job creation in the long term, Trichet added.
"We have the immense responsibility on both sides of the Atlantic to be responsible for price stability and through price stability for paving the way - because it's a necessary condition - for sustainable job creation and growth," he said.
Trichet said the ECB's baseline scenario that risks on economic growth were on the downside while risks to price stability were on the upside did not change, but more information was needed to draw a conclusion on monetary policy.
He reiterated that excess volatility and "disorderly movements" of exchange rates in general are against economic growth and counterproductive, but did not want to comment on whether the current level of the euro was supported by economic fundamentals.
Trichet said the currencies of emerging Asian economies should be more flexible, and warned yen speculators that the market may turn: "As far as the yen is concerned, it is clear that there are good news in the economy that should be progressively taken into account by the markets."
Last week, the Bank of Japan kept rates unchanged at 0.5%, but Governor Toshihiko Fukui said the bank expected inflation to move into positive territory "in the not so distant future."
Carry traders - who borrow in the low-yielding yen to invest in higher-yielding currencies, including in the emerging markets - should beware, Trichet said. "They should be fully aware of the fact that there are two-way risks in this domain."
Markets Were Warned
He said the liquidity turbulence which started in August had been anticipated by central banks all over the world, who had warned investors that risks were under-priced.
"We were warning absolutely all market participants, across the board, that one had to be prepared for a market correction that would call for another pricing, a more correct pricing, of risks," Trichet said.
He defended the ECB's reaction to pump liquidity into the money markets one day after institutions in the US could not roll over commercial paper, which in turn created big tensions in Asian markets, spilling over in Europe.
"We decided to lend on a 24-hour basis at full collateral at the price we had fixed, 4%," he said. "Of course we got it back the next day."
"We had done what was necessary, without bailing out anybody, without giving money to anybody but permitting those who had behaved properly to be in a situation where they were not hit by the bad behavior of some," Trichet added.
As markets slowly return to normal, investors and officials must be on guard for future turbulence, he warned. The new financial structures brought by innovation in the markets had created prosperity but had also yet to be fully tested, he said.
"Creativity and inventivityin the financial markets are absolutely of the essence," Trichet added. "That being said, it is clear that we have also permanent lessons to be drawn from this structural transformation of the financial markets."