ECB's Draghi says must watch inflation threat

Monetary policy makers must closely watch emerging inflation tensions to head off any decline in expectations for price stability, European Central Bank Governing Council member Mario Draghi said on Saturday.

In a speech in the northern Italian town of Verona, Draghi said core inflation in the euro area remained low, despite sharp rises in commodity prices which pushed consumer inflation in January to 2.4 percent, well above the ECB's target zone.

However, the appearance of inflationary tensions does require that we carefully assess the timing and methods for restoring normal monetary conditions and interest rates, he said, according to a text of his speech.

Monetary policy must prevent a deterioration of expectations, in order to keep the stimulus of international prices from passing through to domestic prices and wages in the longer-term.

Draghi's comments, which chime with warnings from other policy makers of mounting inflationary pressures, come a day after data in Germany, the euro area's biggest economy, showed pressure on consumer prices continued in February.

The ECB is expected to leave interest rates at a record low of 1 percent next week but recent comments from board members have strengthened expectations that it could start gradually withdrawing its crisis support next month.

Draghi, a leading contender to take over as president of the ECB when current incumbent Jean-Claude Trichet steps down later this year, said that a gradual tightening of policy would not necessarily threaten growth prospects, even in weaker economies.

Real short-term interest rates that are markedly negative, as they have been over the past two years, have not improved the growth prospects of the less dynamic economies, he said. As economic policies reach the end of their expansionary phase, this will not necessarily endanger growth.

In the weakest countries, in particular, the cost of borrowing could benefit from the narrowing of spreads on government securities following the adjustment of budget policies and from the containment of risk premiums as inflation expectations are kept under control, he said.

He said the world economic recovery was continuing amid considerable uncertainty and sharply divergent growth rates could easily accentuate the volatility of exchange rates and interest rates, jeopardizing the recovery.

Referring to the turmoil that has swept north African countries including OPEC member Libya, Draghi said that in addition to the human dimension of the crisis, the unrest could have a potential impact on growth by pushing up oil prices.

He said Italy, one of the slowest growing economies in the world over the past decade and one which depends on imported energy, a 20 percent rise in oil prices would cut half a percentage point off growth over three years.

(Writing by James Mackenzie; editing by James Jukwey)