ECB holds tough line on inflation

BRUSSELS/LISBON (Reuters) - European Central Bank policymakers held their tough line on inflation risks on Tuesday despite fresh turmoil on financial markets and an emergency cut in U.S. interest rates.

The ECB declined to comment on the U.S. Federal Reserve's 75-basis-point interest rate cut, which took U.S rates below the euro zone's for the first time since late 2004 and surprised some people at the ECB as well as market participants.

But Luxembourg Prime Minister Jean-Claude Juncker, who sits in on ECB Governing Council meetings, said he did not expect the ECB to follow suit, and comments by ECB policymakers suggested there was no consensus for such a move.

Executive Board members Juergen Stark and Jose Manuel Gonzalez-Paramo said the euro zone's economic fundamentals were sound, and pointed to continued upward pressure on inflation, a stance echoed by German Bundesbank President Axel Weber.

Nonetheless, there was some division on the economic outlook. Portuguese central bank governor Vitor Constancio said European growth could be slower than earlier expected, comments which were in line with growing market expectations that the ECB may have to change tack before the end of the year.

The ECB has kept interest rates at 4.0 percent since mid-2007 but economists believe the Governing Council is increasingly squeezed by the prospect of slower growth on the one hand and price risks on the other.

"Our main concern is the high inflation rate of 3.1 percent" in the euro zone, Stark said, adding that the ECB was "very worried and alarmed" about inflation in an interview with German newspaper Die Zeit conducted on Tuesday after the Fed decision.

Earlier, giving a speech in Brussels, Stark also passed up on the opportunity to comment on the rate cuts by the Fed and the Bank of Canada, saying he had only just received the news and did not know all the details. "I have to talk to my colleagues," he told reporters.

But Juncker told Luxembourg television later in the day that he did not think the ECB would follow the Fed's lead.

"The central bank is right to advocate price stability. I don't expect the ECB to take a similar rate step as the American central bank, meaning to adjust rates downwards," he said.

INFLATION VS GROWTH

Gonzalez-Paramo said the ECB would, as always, do what was needed to protect price stability, but that it was not possible to say how market turmoil would influence inflation. For its part, growth was still holding up.

"The main scenario is growth consistent with potential, which is around two percent," he told Portuguese broadcaster SIC before the Fed announcement. "The fundamentals of the European economy remain solid."

Weber said the ECB would not allow current inflation at 6-1/2-year highs to spill over into wage demands and consumer prices. "We have zero tolerance for a wage-price spiral. If financial and wage developments threaten to leave the stability corridor, we will act decisively," he said in an interview with German magazine Focus Money.

ECB Vice President Lucas Papademos, speaking in Luxembourg, also said it was "more important than ever" that central banks did not take their eye off inflation.

But he was guarded about the ECB's outlook for growth of around 2 percent this year, which three policymakers have called into doubt in the past week.

"There is a lot of uncertainty ... for a few months we have stressed the existence of heightened uncertainty and downside risk."

"It is not unimaginable that economic activity will be sustained at a level close to potential growth.

Constancio struck a more cautious note on inflation, noting that this was also influenced by real economic developments, and said Europe would not be immune to the rising risk of a U.S. recession.

"Certainly the probability has increased and that's a consequence of a revision of expectations by investors worldwide," he told Reuters during a conference in Lisbon.

Stark and Weber played down the prospect of a U.S. recession, saying growth should continue albeit at a weaker pace.

They also shrugged off renewed turbulence on financial markets, after European shares sank 6 percent on Monday, their biggest one-day slide since the September 11, 2001 attacks amid concern about the scale of the U.S. economic slowdown and fears of more financial sector losses.

"Financial markets tend to overreact," Gonzalez-Paramo said. "There is overshooting and undershooting. I would not make a full story out of what happened yesterday."

Stark repeated earlier calls for more transparency and said the process of market correction would probably continue for a while.

"The markets are very nervous," he said. "But we are seeing an overreaction. Fear and panic are bad advisers. We should not forget the facts. Fundamental economic data are good."

(Additional reporting by Sergio Goncalves in Lisbon, Philip Blenkinsop and Michele Sinner in Luxembourg and Klaus Lauer and Iain Rogers in Berlin; writing by David Milliken and Krista Hughes; editing by David Stamp)