ECB's Panetta calls for small rate hikes as inflation falls

LONDON, Feb 16 (Reuters) - The European Central bank should start raising its interest rates in smaller increments and avoid committing to future moves as inflation in the euro zone falls, ECB board member Fabio Panetta said on Thursday.

The ECB raised rates by a historically large 50 basis points earlier this month and pre-announced another increase of the same size for March 16 as it extended a dogged fight against high inflation in the euro zone.

But Panetta, Italy's appointee on the ECB's board, called for caution, saying a streak of hikes that saw the central bank raise rates by 300 basis points since July had yet to be completely felt by the economy.

"With rates now moving into restrictive territory, it is the extent and duration of monetary policy restriction that matters," Panetta told an event in London.

"By smoothing our policy rate hikes – that is, moving in small steps – we can ensure that we calibrate both elements more precisely in the light of the incoming information and our reaction function."

The comments put him at odds with some of his colleagues north of the Alps, such as the Netherlands' Klaas Knot and the Bundesbank's Joachim Nagel, who clamoured for more, big hikes.

Financial markets expect the ECB to increase the rate it pays on bank deposits to at least 3.5% by the summer, from 2.5% currently.

He estimated that headline inflation in the euro zone may fall below 3% by the end of the year if the drop in energy prices is sustained -- all the way down from 8.5% last month.

This would also be lower than the ECB's projection for 3.6% inflation for the last quarter of this year -- courtesy of a stronger euro and lower electricity prices compared to when those forecasts were published in December.

Panetta also predicted that core inflation, which has become the key variable in the ECB's debate, "would eventually follow" headline inflation in falling and there was no evidence of price expectations getting out of control despite rising wages.

He also called for a "a measured approach" to the ECB's unwinding of its bond holdings, which Knot and Nagel, among others, want to accelerate.

Reporting By Marc Jones; Writing by Francesco Canepa in Frankfurt; editing by Balazs Koranyi and Sharon Singleton

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