UPDATE 1-Negative interest rates an option for ECB, says Liikanen

Tue Feb 11, 2014 7:53am EST

* Says ECB must be ready if inflation outlook worsens

* Negative deposit rates one tool that has been discussed

* Does not see signs of deflation in the euro zone

* Says OMT "totally compatible with our mandate"

* Possible some banks may be wound down after health check

LONDON, Feb 11 (Reuters) - Negative interest rates are a policy option for the European Central Bank should the euro zone inflation outlook deteriorate, ECB Governing Council member Erkki Liikanen said on Tuesday.

The ECB left rates at a record low last Thursday but put markets on alert for a possible move in March, acknowledging that emerging-market turbulence could hit the euro zone.

The central bank held its main refinancing rate at 0.25 percent and the deposit rate it pays banks for holding their cash at zero on Feb. 6.

Asked at a House of Lords' committee hearing in London whether negative rates were an option for the ECB, Liikanen replied: "If our inflation outlook worsens, we must be ready for that. Among all these tools, which we can consider and which we have discussed, negative deposit rates is one of those."

"But of course, when we take policy decisions in our monetary policy meeting, it's based on the most recent data and careful preparation," he added.

Euro zone inflation slowed to 0.7 percent in January, well below the ECB's target of just under 2 percent.

At their March meeting, ECB policymakers will have more information at their disposal, including new forecasts from the bank's staff that will extend into 2016 for the first time.

Despite inflation undershooting the ECB's target, Liikanen dismissed concerns that deflation could grip the euro zone.

"Deflation means normally a broad-based fall of prices over a prolonged period and on a broad front, and we don't have signs of deflation in the euro area," he told the committee hearing in London, speaking via video link.

Turning to the ECB's Outright Monetary Transactions (OMT) bond-buying plan, which Germany's top court said last week appeared to violate a ban on the ECB funding governments, Liikanen said the programme was "totally compatible with our mandate."

He said emerging market turmoil could last some time but added that "the euro area has been quite resilient to this turbulence."

On the issue of the ECB's banking sector health checks, Liikanen said: "It is totally possible that some of these banks will not go (successfully) through the test and may be wound down. It is possible."

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