Inflation easing but no all-clear: ECB bankers

People walk by a shop with discount signs announcing summer sales in Paris, June 25, 2008.

FRANKFURT/VIENNA (Reuters) - Euro-zone inflation has probably passed its peak but the European Central Bank cannot let down its guard against a wage-price spiral, ECB policymakers said on Friday.

After leaving interest rates on hold at 4.25 percent on Thursday, central bankers stressed they remained on alert about inflation risks and signaled they were not planning to bow to growth worries and loosen policy soon.

"Without a stable level of prices, there will be no sustainable economic recovery and no sustainable economic growth," ECB Executive Board member Juergen Stark said at a conference in Frankfurt.

"Inflation remains at worrying levels and financial tensions persist. If anything, the challenges for monetary policy are intensifying rather than waning."

Stark said he expected inflation to moderate in the months and quarters to come, a view backed by new Austrian central bank chief Ewald Nowotny, but they and others stressed that the risk of a wage-price spiral remained alive.

In an interview with Reuters in Vienna, Nowotny said: "We have a trend, we have a tendency that it is going downwards."

"But one always needs to point out that the inflation rate is still far too high in its overall level, which means there is no reason whatsoever to give the all-clear."

Lower oil prices brought inflation in August down to 3.8 percent in the 15-nation region from a record 4 percent, but it remains double the ECB's goal of just below 2 percent.

ECB President Jean-Claude Trichet said on Thursday he did not expect to reach this level until 2010 and sharpened warnings on second-round effects, just as German union IG Metall flagged demands for wage rises of 7-8 percent for some workers.

Speaking in San Sebastian in Spain, Executive Board member Jose Manuel Gonzalez-Paramo said there was "acute concern" about knock-on inflation and noted high market inflation expectations.

"If these expectations become permanent in the system, we are lost," he said, a point also made by Cyprus central bank governor Athanasios Orphanides.

Orphanides said the easing in August inflation did not suggest a rapid improvement and the economy would still feel further pain from past commodity price rises.

"Tolerating second-round effects can be devastating for an economy", he said. "Policy should not allow this to happen."

STEADY HAND

The euro zone economy contracted in the second quarter and both Nowotny and Gonzalez-Paramo said risks to the future outlook were notably on the downside.

Stark said it was very likely growth in the third would also be weak, before a "gradual recovery" in 2009.

ECB staff cut forecasts for growth to about 1.4 percent this year and 1.2 percent in 2009, but raised their outlook for inflation to about 3.5 percent in 2008 and 2.6 percent in 2009.

Markets expect the ECB to keep rates on hold at the current seven-year high until well into next year, although investors are betting on rate cuts in mid-2009.

On the sidelines of the Frankfurt conference, Trichet said he had nothing to add to his comments on Thursday, when he said the ECB had no bias and was not precommitted to any action.

Sticking to a firm monetary policy framework was even more important in times of market upheavals and Trichet said central bankers had to be permanently alert to excessive complacency by investors about risk.

ECB Executive Board member Lorenzo Bini Smaghi said markets may have overreacted to the ECB's tightening of rules on the assets that it accepts in its liquidity operations.

The ECB plans to increase the risk margin it charges on for banks using asset-backed securities and unsecured bank bonds as collateral to borrow money from the central bank.

"I think this is not a particular tightening, it's ... in line with sound risk management procedures," Bini Smaghi said.

Stark urged investors to return to the markets and warned banks should not become dependent on the ECB to provide the liquidity needed to trade.

"It is not the central role of the central bank to replace the markets, he said, although the ECB would keep providing funding for as long as market tensions remained.

Trichet denied the changes to the collateral rules were a back-door rate rise, and said the changes had nothing to do with monetary policy.

(Additional reporting by Jonathan Gould and Krista Hughes in Frankfurt and Andrew Hay in San Sebastian; Editing by Ron Askew)