FRANKFURT (MNI) – Risks to medium-term price stability in the euro
area could move to the upside and the ECB stands ready to act in that
case, ECB Executive Board member Juergen Stark said Monday.

Stark said that the ECB’s easy policy stance has become
increasingly accommodative and must be normalized over time as financial
markets and the economy continue to improve. Importantly, he also
pointed out that in his view the recovery is increasingly
self-sustaining.

Stark warned that imported inflation pressures must be taken
seriously and taken into consideration when setting Eurozone policy.
Indeed, there are already early warning signals for domestic inflation,
he said.

“ECB that has already been accommodative has become even more
accommodative. In my view, risks to the medium-term outlook for price
developments in the euro area as a whole could move to the upside,”
Stark said in a speech text released by the central bank.

“To the extent that financial market conditions continue to improve
and the current economic recovery turns out to remain strong and
self-sustained, the stance would need to be normalized over time,” Stark
said.

He observed that the “economic recovery in the euro area is
increasingly self-sustaining and increasingly less dependent on state
support measures” but added that “uncertainty remains high.”

“We will act whenever we anticipate that higher costs and price
increases pose upward risks to price stability over the medium term,”
Stark said.

Stark’s assessment of the current price environment suggests such
upside risks may be developing soon.

“Inflation rates could temporarily increase further in the next few
months and are likely to stay above 2% in 2011, before moderating again.
There is continued evidence of upward pressure on overall inflation
mainly owing to energy and commodity prices,” Stark said.

In addition, “industrial producer prices, which have some early
indicator properties with respect to consumer prices, have strongly
accelerated in the course of 2010 and are currently growing at rates
above 5%. Available survey data also point to increasing price pressure
in the earlier stages of the production process,” Stark observed.

Echoing comments by other ECB Council members, Stark stressed that
the central bank is paying close attention to spillover risks and “will
act quickly and decisively on any indications of emerging second-round
effects and of a dis-anchoring of inflation expectations from levels
consistent with price stability.”

He also warned that persistently high commodity prices should not
be ignored and may have to be taken into account when setting Eurozone
policy.

“The commodity price pressures…reflect to a large extent strong
demand from emerging economies and may not revert as quickly as if they
were due to short-lived tensions in supply,” Star said. Coupled with
ample liquidity this could lead to inflation on the euro area.

Policy-makers should not repeat the mistake from the period from
end-2005 to mid-2008 when warning signals for a more persistent upward
pressure on euro area inflation stemming from commodities were not taken
seriously enough, Stark argued.

“Monetary policy for the euro area can of course not control strong
global liquidity trends, but it needs to take them into account and
possibly apply a more restrictive view on domestic liquidity expansion
than would otherwise be the case,” he said.

Turning to non-standard measures, Stark said that “keeping policy
rates at very low levels for a protracted period and at the same time
generously providing liquidity to banks entails significant risks” by
spurring a “search for yield” that could lead to new imbalances.

The ECB will decide whether so-called addicted banks — should they
still resort to ECB funding extensively once markets are closer to
normal — will continue to get support on the basis of “whether their
funding constraints are a result of remaining market problems or whether
they are primarily attributable to weaknesses in their balance sheets,”
he said.

If the latter is the case, “it is the responsibility of the
national central banks at their risk and cost, possibly guaranteed by
the government, to act as the lender of last resort,” Stark asserted.

Stark said that “non-standard measures can co-exist with any
interest rate level.”

“Hence, should market conditions still warrant some of the
non-standard measures once upside risks to price stability over the
medium term require our action, the monetary policy stance can be
changed,” he added.

–Frankfurt bureau, +49-173-6529-331; jtreeck@marketnews.com

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