January 13, 2011 / 9:30 AM / 9 years ago

UPDATE 5-ECB says ready to act on inflation if needed

* Trichet sees short-term inflation pressures

* Warns of letting pressures take hold in medium-term

* Puts onus on governments to cut debt, solve crisis

* Rates on hold, as they have been since May 2009

(Recasts top of story)

By Paul Carrel

FRANKFURT, Jan 13 (Reuters) - The euro zone faces short-term price pressures which could linger, the European Central Bank said on Thursday, showing it could raise interest rates to contain inflation even while the bloc is gripped by a debt crisis.

ECB President Jean-Claude Trichet said prices needed to be monitored very closely after euro zone inflation jumped last month to 2.2 percent, the first time in two years it has risen above the central bank’s target of just below 2 percent.

The ECB left rates on hold at a record low of 1 percent — a level Trichet said was “still appropriate”. Risks to the medium-term outlook for price developments were still broadly balanced, “but could move to the upside”, he added.

“We see evidence of short-term upward pressure on overall inflation, mainly owing to energy prices, which has not so far affected our assessment that price developments will remain in line with price stability over the policy-relevant horizon,” Trichet told a news conference.

“We are permanently alert. We are never pre-committed not to move interest rates and our level of interest rates is designed to permit to deliver price stability.”

The euro EUR= extended its gains versus the dollar in response to his remarks and short-dated bond yields rose.

“He sent a mild warning to markets that the ECB’s assessment on interest rates could change,” said Commerzbank economist Michael Schubert.

“What was more striking was that he emphasised that the ECB raised rates in July 2008, which stresses that the ECB could still raise rates in very uncertain times.”

In 2008, the ECB hiked rates due to oil price-fuelled inflation just ahead of the Lehman bankruptcy that tipped the global financial system into full-blown crisis.

Trichet made a point of reminding reporters of that but said that while inflation could remain above target for a while, it was likely to subside towards the end of the year.

With inflation taking off, most notably in fast-growing emerging economies, several countries are already raising rates. South Korea and Thailand were the latest Asian economies this week to tighten as policymakers battle the impact of surging prices of food and other commodities. [ID:nSGE70A06P]

“There is maybe a bit of a shift but I would not overdo it,” Goldman Sachs economist Dirk Schumacher said of the ECB’s stance on inflation. “One meeting is not enough to signal a major shift considering how volatile the situation is likely to remain.”

The Bank of England also kept its interest rates on hold on Thursday at a record-low level of 0.5 percent. [ID:nLDE70C1CG] Markets are starting to price in a UK hike by the summer rather than near the year’s end given inflation there has been above target for much of the last three years.

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For a graph of bond purchases click:

r.reuters.com/wum27q

For a graph of bond spreads click:

here

For a graphic on the ECB’s policy dilemma of rising

inflation and diverging growth, click on:

r.reuters.com/var94r

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DEBT CRISIS

Trichet put the onus firmly on euro zone governments to put their own houses in order to draw a line under the euro zone debt crisis which has forced Greece and Ireland to seek bailouts.

Successful bond auctions by Spain and Portugal this week eased some of the fears they may be next to seek outside aid.

“In view of the ongoing vulnerability to adverse market reactions, countries need to do their utmost to meet their deficit targets and put government debt and GDP ratios firmly on a downward trajectory,” Trichet said.

He reaffirmed his support for the size and scope of the 440 billion euro ($574 billion) rescue fund to be increased, something top EU officials are pushing for, although Germany says it is opposed.

“We thought that this stabilisation fund should be improved quantitatively and qualitatively,” Trichet said.

Investors wonder whether the ECB can increase its bond purchase programme to support Portugal, the latest government under pressure in a crisis which policymakers want to halt before it reaches the much bigger Spanish economy.

The pressure on the ECB to buy bonds may have been eased by Portugal’s success in an auction of its benchmark 10-year bond on Wednesday, a similarly solid debt sale by Spain on Thursday and a call from the EU’s top economic official for a stronger European financial safety net. [ID:nLDE70C15C]

It did, however, buy Portuguese bonds to ease the path to its auction this week.

Trichet merely said the programme was “ongoing”.

The programme, which has left the ECB exposed to potential losses, has divided opinion within the bank, with Germany’s Bundesbank chief Axel Weber voicing his opposition publicly. [ID:nLDE69B266]

Keeping its bond buying plans ambiguous affords the ECB an element of surprise when it acts, generating more impact. (Additional reporting by Marc Jones and Sakari Suoninen, editing by Mike Peacock)

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