UPDATE 1-ECB to unwind low rates when recovery starts-Stark

* Stark says ECB to reverse low rates as economy picks up

* Euro zone economy no longer in free-fall

* Governments should seek exit strategies from stimulus

* Govt bond yields may rise further as economy recovers (Changes dateline, adds byline, Stark quotes, Weber)

By Eva Komarek

LINZ, Austria, June 8 (Reuters) - The European Central Bank will reverse its very low interest rate policy once the economy starts to recover and price pressures re-emerge, Executive Board member Juergen Stark said on Monday.

Stark said the ECB's focus on ensuring stable prices would not waver, and it was clear the central bank could not keep up its current level of support forever, noting the economy was no longer in "free fall."

"Maintaining price stability will remain the only objective that guides our decisions," he said in a speech at an Austrian Industrial Organisation event.

"This implies that the very accommodative monetary policy stance we are pursuing now will be reversed once the economy starts to recover and upside risks to price stability emerge again."

Stark's comments underline the resistance among some at the ECB toward taking rates any lower than the current record low of 1 percent and are the most explicit to date about the triggers for future rate hikes.

Most economists polled by Reuters forecast unchanged rates through 2010, and the International Monetary Fund said on Monday ECB should consider further cuts as soon as possible. [ECB/INT] [ID:nWEA6001]

The ECB expects the euro zone economy will start to grow again by mid-2010, although inflation is seen well below its price stability goal of below -- but close to -- 2 percent next year, reducing the scope for tightening. [ID:nL4997231]

Fellow policymaker Axel Weber, speaking in France, also stressed the need for a timely exit strategy and said the ECB would wind back its policy of lending banks unlimited funds in time to counter potential inflation risks and help avoid future financial crises.

"Should the overall economic picture improve, the Eurosystem will absorb the extra liquidity provided as quickly as possible," Weber said. [ID:nLAG003491]

NO FREE FALL

Stark said there was evidence the euro area economy, which has contracted about 4 percent in the last two quarters, would shrink further in the second quarter, but the pace was slowing.

"The economy is no longer in free fall; we are seeing the first signs of stabilization he said.

"Indicators of consumer confidence and business sentiment have continued to improve somewhat. We are also seeing some encouraging signs of normalization in financial markets."

Stark repeated the assessment given by ECB President Jean-Claude Trichet last week that the euro zone economy would remain weak for the rest of 2009 and recover only gradually during 2010.

Quarterly growth rates would turn positive by mid-2010, he said, and inflation would remain subdued.

"Inflation rates are likely to enter negative territory during the summer, but we expect them to turn positive by the end of 2009," Stark said, noting the impact of past energy price falls.

He dismissed the chance of deflation in the 16-nation region and said the process of disinflation was "of no concern to the ECB, which aims to maintain price stability in the medium term."

Stark urged euro zone governments to avoid the temptation of extra fiscal stimulus and said they must plans for fiscal consolidation or risk eroding public confidence.

He noted governments had not laid out a clear exit strategy from stimulus programs and said past fiscal behavior could play a role in pushing up the yields on government bonds.

"So far, most euro area countries have enjoyed relatively low interest rates on new government debt issuance, despite facing considerably more difficult market conditions," he said.

"Looking ahead, as the economy recovers and competition for financing increases, governments may face higher bond yields again."

Restructuring the banking sector should be the top policy priority and is key to economic recovery, Stark said.

The ECB supported establishing a new European Union body to consider systemic risks to the financial system, to be chaired by the ECB president, but would not use interest rates to act against risks in the banking sector.

For a copy of Stark's speech, please see: here (Additional reporting by Sakari Suoninen in Frankfurt) (Writing by Krista Hughes; Editing by Victoria Main)