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ECB's Trichet warns on complacency as economy heals

JACKSON HOLE, Wyoming (Reuters) - European Central Bank President Jean-Claude Trichet warned policy-makers from around the world on Saturday not to forget the lessons of the devastating financial crisis now that the worst has passed.

Bank of Japan Governor Masaaki Shirakawa (L), European Central Bank President Jean-Claude Trichet (C) and U.S. Federal Reserve Chairman Ben Bernanke talk outside the Jackson Lake Lodge during a break in the Federal Reserve's Jackson Hole Economic Symposium in Jackson Hole, Wyoming, August 21, 2009. REUTERS/Price Chambers

Speaking at the close of a two-day annual Federal Reserve retreat, Trichet -- who at the same conference last year was fretting about inflation only weeks before investment bank Lehman Brothers collapsed -- urged his peers to do everything they could to prevent a repetition of such “dramatic events.”

“Now that we see some signs confirming that the real economy is starting to get out of the period of ‘free fall’ ... the largest mistake we could make would be to forget the importance and the urgency of this task,” he said, warning of a possibly “very bumpy road ahead.”

Trichet and other central bankers, meeting in the shadows of Wyoming’s majestic Grand Teton mountains, took cautious note of signs suggesting the worst of the devastating economic storm was over, while promising to rebuild fractured financial systems to better withstand future crises.

RECOVERY ARRIVES, BUT RISKS REMAIN

The economies of France, Germany and Japan have emerged from recession, and the U.S. economy appears to be returning to growth as well. U.S. stocks ended the week at 2009 highs on Friday after a big rise in home sales and optimistic comments from Fed chief Ben Bernanke.

Opening the conference, which drew together prominent academics and top officials from 35 central banks, Bernanke said the global recession was ending, but he warned growth would be sluggish for a time.

However, the recovery is built on government life support and its sustainability is still in doubt. Officials tempered their optimism with talk of the difficulties that lie ahead, including the tricky question of how and when they should pull back the massive support they have provided their economies.

ECB Governing Council member Ewald Nowotny told Reuters on Saturday that Europe’s economy will improve in the second half of the year, but that a sustained recovery will likely not take hold until early 2010.

LOW RATES, LOW INFLATION

One worry for many policy-makers is whether the United States can reverse its aggressive programs that have flooded the ailing economy with cash in time to avoid inflation.

A paper presented at the conference argued the Fed’s stated intention to keep interest rates low for an extended period could be incompatible with its goal of keeping inflation down, a conclusion rebutted by Fed Vice Chairman Donald Kohn.

“The commitment to low rates is designed to keep inflation from falling and falling persistently below what we might want it to be for a long time,” Kohn said. “It’s not designed to raise inflation expectations.”

The Fed chopped benchmark U.S. rates to near zero in December and it has pumped hundreds of billions of dollars into the economy to help boost economic activity and turn back a recession that has proven to be the deepest since the 1930s.

St. Louis Federal Reserve Bank President James Bullard, told Reuters on Friday that markets do not fully grasp that the Fed’s pledge to keep rates exceptionally low for an extended period means mean borrowing costs will stay down beyond the point that normal rules of thumb would call for raising them.

Kohn also defended the U.S. central bank’s decision to buy long-term securities as an emergency measure to spur growth after it had cut interest rates as far as it could. Economists, including some officials at the Fed, have questioned how successful those purchases have been in lowering rates.

Another ECB official told participants that the ECB was not likely to deviate from its inflation targeting strategy, and warned that pulling benchmark euro zone rates down to near zero, as the Fed has done, could unsettle markets.

“The zero lower bound may interfere with the functioning of financial markets, thereby upsetting the stimulative impact of very low rates,” said ECB Executive Board member Juergen Stark.

Some economists have criticized the ECB for moving less aggressively than the Fed to spur economic activity, and Trichet defended the ECB’s policy approach.

“Criticizing a central bank that is acting with a steady hand for being ‘behind the curve’ rather misses the point,” he said. “A gradualist approach of this kind may be the most effective antidote to the threat to price stability.”

Additional reporting by Kristina Cooke; Editing by James Dalgleish and Tim Ahmann

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