UPDATE 1-Budget cuts must go on, EU's Rehn says
* EU executive urges countries to meet fiscal targets
* IMF, economists point to damaging impact of austerity
* Euro zone focus should be on competitiveness, investment unemployment
BRUSSELS, Jan 11 (Reuters) - The worst of the euro zone debt crisis may be over, but governments must not let up on reforms or budget cuts if they want to put the turmoil firmly behind them, the EU's top economic official said on Friday.
In a speech to diplomats and industry officials, EU Economic and Monetary Affairs Commissioner Olli Rehn called for prioritising investment, fighting youth unemployment, continued reduction of budget deficits and tighter economic integration of the 17-member single currency area.
"Our patient may be out of intensive care, but it will still take some time before she can be given a clean bill of health," Rehn said. "That's why any lapse into complacency would be unforgivable. We need to stay the reform course to revitalise the European economy," he added.
To overcome the crisis, the euro zone agreed last year in a special treaty to keep budgets in balance or surplus and cut debt and launched a permanent euro zone bailout fund, the 500 billion euro ($660 billion) European Stability Mechanism (ESM).
Euro zone countries also negotiated a new rescue packages for Greece, including a debt restructuring, and agreed on a loan to recapitalise Spanish banks. They decided the euro zone will have a banking union with a single supervisor and, eventually, a joint bank resolution mechanism and deposit guarantee scheme.
The move that finally convinced investors was the European Central Bank's promise to buy unlimited amounts of bonds of a government that asks for ESM help and agrees to reforms.
But lower deficits were still central to emerging from the three-year public debt crisis, Rehn said, even though their is increasing debate about the impact of austerity on growth.
The International Monetary Fund said late last year that the damage from aggressive austerity may be up to three times more than previously thought, after earlier prescribing sharp deficit cuts to the euro zone. The IMF has since shifted its advice, now arguing against forcing heavily indebted countries such as Greece to reduce their deficits too quickly.
Rehn said the IMF's October study, which was updated this month, was not applicable to everyone and did not take into account that investors expect governments to control their debt.
"You have to take into account the confidence effect," Rehn said, adding that the impact of austerity differed across countries depending on whether they still had access to markets.
NO WORD ON SPAIN
The difference in opinion may mark a split within the "troika" of international lenders - the Commission, the IMF and the European Central Bank - over how to deal with fragile European economies trying to pull out of recession in 2013.
Against a backdrop of record unemployment, many economists believe spending cuts in almost all euro zone countries drove the bloc into its second recession since 2009 last year.
But ECB chief Mario Draghi has also rejected any idea of easing up on efforts to reduce sovereign debt.
"So much progress accompanied by so big sacrifices have already taken place that to revert to a situation that has been found to be untenable would not be right," he told the ECB's monthly news conference on Thursday.
Rehn said that government spending cuts had now made budgets and public debt loads more sustainable but that more had to be done because debt burdens were still high.
When it comes to monitoring progress, the Commission will look at government efforts in structural terms - excluding the effects on revenue and spending of the business cycle.
Each country will be reviewed separately on cutting its budget deficit below the EU ceiling of 3 percent of gross domestic product, above which the gap is seen as excessive.
Asked if the Commission planned to propose more time for Spain, which is in recession, to reduce its deficit, Rehn said the country already won a one-year extension until 2014.
"If growth deteriorates unexpectedly, a country may receive extra time to correct its excessive deficit, provided it has delivered the agreed fiscal effort. Such decisions were taken last year for Spain, Portugal and Greece," Rehn said.
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