UPDATE 1-ECB's Papademos: Strive to avoid nationalizations

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By Kristina Cooke and Pedro da Costa

NEW YORK Feb 20 (Reuters) - European Central Bank member Lucas Papademos said on Friday that countries should strive to avoid nationalizing banks even though it may not always be possible as the financial crisis drags on.

Nationalizations should be avoided "to the maximum extent possible," he said after speaking on a panel at New York's Columbia University.

Given the backdrop of the financial crisis and a deep global downturn, Papademos expects euro zone inflation to decline sharply this year, potentially briefly approaching zero.

"On the basis of current market expectations and our assessment on the evolution of domestic inflationary pressures, we do expect inflation will decline considerably this year, approaching zero for a short period of time," he said.

That said, Papademos expects the slide to be short-lived, with inflation ticking back up "in the second part of 2009 and beginning of 2010" to a level that the ECB considers consistent with price stability.

Papademos said that while the ECB has not decided on the appropriateness of further non-conventional policies, he said such policies should be viewed separately from interest rate policy.

"All central banks should be prepared to take any action which is necessary to preserve price stability and contribute to the safe-guarding of financial stability," he said.

Papademos said the ECB's emergency support for money markets has seen some success. "The liquidity we are providing in the money market has progressively contributed to the conditions in the market," he said.

"You will see that the spread has progressively declined This in turn helps reduce the cost of lending to households and firms."

He noted that bank lending rates have "declined considerably" in the euro-zone, both as result of ECB interest rate cuts and improvements in credit markets. Asked if expectations of further interest rate cuts may also be pushing bank lending rates lower, he said: "The market has expectations."

Speaking on the panel, Papademos stressed the importance of the need to formulate an exit strategy for emergency central bank policies and government stimulus packages.

"We need to prepare ground for (an) exit strategy," he said.

Even if interest rates are a relatively blunt instrument, it is the main policy tool, Papademos said, adding that it was a good idea for monetary policy to "lean against the wind" when times are good.

He also said it was important to rethink the regulation of the financial system. "Completion of a reform agenda is very important," he said.

Papademos rebuffed criticism that the ECB had acted too slowly in battling the crisis.

"I believe that this criticism is unfounded. I think the ECB has acted in a decisive and timely fashion," he said. (Reporting by Kristina Cooke and Pedro da Costa; Editing by Dan Grebler)