ECB ready to cut if price pressures ease

BERLIN, Jan 3 (Reuters) - The European Central Bank stands ready to reduce interest rates further if it sees that risks to price stability have diminished, ECB Vice President Lucas Papademos told a German magazine.

The ECB has reduced rates by 175 basis points since October, bringing its benchmark rate to 2.5 percent. Markets expect the bank to cut by at least another 50 basis points when it holds its next policy meeting on Jan. 15.

"If, in our assessment, the risks to price stability change further in the coming months, monetary policy could be eased further and we will act appropriately," Papademos told Wirtschaftswoche in an interview published on Saturday.

His quotes are based on an English version of the interview provided by the ECB shortly after the magazine's German version was released.

Papademos said he expected economic activity in the 16-nation euro zone to contract over the next two to three quarters, predicting a recovery towards the end of 2009 or early next year.

He said it would be premature to revise down an ECB projection for the euro zone to contract by 0.5 percent in 2009, but said he could not rule out a weaker performance and noted that "the risks to growth are on the downside".

He said inflation in the currency bloc could ease "substantially" towards the middle of this year before picking up again at the end of 2009 without endangering price stability.

Papademos acknowledged that in the current economic situation, monetary policy changes took longer to have an effect on growth and said their overall impact was weaker than usual.

"Even under normal circumstances it takes four to six quarters for a change in the central bank interest rate to exert its maximum impact on GDP," he said. "In the current environment it is likely that these time lags will be even longer. But this does not mean that monetary policy has lost its influence on the economy."

Papademos said euro zone governments had a role to play in stimulating their economies, but warned against measures that would hit confidence in public finances or threaten the credibility of the European Union's Stability and Growth Pact.

Asked about Germany, where the government is under pressure to include tax cuts in a second stimulus package to be finalised later this month, Papademos said: "I am sceptical that in times of exceptional uncertainty and low confidence, economic activity will really benefit from a temporary tax relief.

"Households are likely to save, rather than spend, any increase in income from a temporary reduction in taxes." (Writing by Noah Barkin; editing by Chris Pizzey)