ECB lays ground for next hike, talks tough on debt

By Toni Vorobyova and Paul Carrel

MOSCOW/LJUBLJANA (Reuters) - Top ECB policymakers sent fresh warnings about rising euro zone inflation risks on Thursday, with one likening the current economic situation to that at the start of the bank's last rate hike cycle in 2005.

The ECB raised rates to 1.25 percent last Thursday, beginning what financial markets expect to be a steady run of hikes despite assurances from the bank's President Jean-Claude Trichet that a cycle of increases is not pre-programed.

ECB Executive Board members Jose Manuel Gonzalez-Paramo and Lorenzo Bini Smaghi both focused on rising euro zone inflation on Thursday, fuelling expectations among economists that the bank will raise rates again in either June or July.

"Risks to growth are balanced, inflation (risks are) to the upside," Gonzalez-Paramo told reporters on the sidelines of the Risk & Return Russia conference in Moscow.

"Oil prices are the main driver of the recent increase in inflation. The expectation in the market is that oil will not go down quickly."

In an interview with Reuters, Slovenia's ECB policymaker, Marko Kranjec said the bank's monetary policy was still "very accommodative" after last week's rate rise and that the financial system remained well stocked with ECB funding.

Bini Smaghi, who has been a pacemaker for the ECB's rate hike rhetoric this year, said in an interview with Italian paper Il Sole 24 Ore that the current macro economic backdrop mirrored that of 2005, when the ECB launched a series of hikes that raised rates from 2 percent to 4 percent in 1-1/2 years.

"We are at the end of an easing cycle with very low interest rates, as in 2005," he said, defending the increases back then and also the bank's often-criticized additional hike in 2008 just before the collapse of the global economy.

"The minimum levels at which the interest rates were standing were justified by the 2009 recession and the risks of deflation. As we move away from those risks, the less justified these interest rate levels are."


There were renewed signs of higher inflation in China on Thursday, underlining the rise in global price pressures as economies put 2008's financial turmoil behind them. The ECB's monthly bulletin warned that the ongoing geopolitical tensions could also put upward pressure on oil prices, and as a result, euro zone inflation.

"Political turmoil in the Middle East, North Africa region presents a downside risk for economic activity and an upside risk to price developments in the euro area in the short run," it said.

Gonzalez-Paramo and Kranjec gave little away on the likelihood of further rate hikes, contrasting with other ECB rate-setters who recently signaled the bank is ready to tighten monetary policy again in coming months.

The majority of economists and investors currently see the ECB raising interest rates twice more this year to 1.75 percent, but recent tough talk from policymakers has seen some experts shorten the odds of earlier hikes and squeezing in a third one.

The euro hit a 15-month high against the dollar this week as markets eyed the impact of the growing divergence between euro zone and U.S. monetary policy.

Bini Smaghi downplayed the single currency's 11 percent rise since January, however, saying that against the world's major currencies, it was: "at the same level as in 2005 in nominal effective terms and about 10 percent lower in real terms."


Euro zone trouble spots Greece, Ireland and Portugal also came under the ECB spotlight following media reports this month that politicians are increasingly considering the prospect of a possible debt restructuring in Greece.

Bini Smaghi warned that any move by Athens to restructure its debt would have catastrophic effects, ruining its banks and crippling its economy.

Gonzalez-Paramo meanwhile stuck to the official line that Greece should be able to return to open markets early next year if it follows its EU and IMF bailout program.

To coincide with an ECB, IMF and EU trip to inspect Dublin's finances, ECB board member Juergen Stark sent a thinly veiled warning to the country's government, saying emergency central bank aid for Irish banks could not last forever and that burning senior bank bondholders risked igniting problems elsewhere in the euro zone.

"The role of the ECB is to provide liquidity but you cannot say, okay, it is all up to the ECB to fund the Irish banks," Stark said in an interview with the Irish Independent.

"It is not a healthy situation that we are providing liquidity of up to 100 pct of GDP to the Irish banks," he added.

(Writing by Marc Jones; editing by Patrick Graham)