With inflation risks to upside, ECB may need to hike more, Dolenc says

By Balazs Koranyi

LJUBLJANA, Oct 8 (Reuters) - The European Central Bank may have to keep raising interest rates given an abundance of upside inflation risks but the timing and size of any move remain far too uncertain to predict, ECB policymaker Primoz Dolenc said.

The ECB can also take some comfort in the composition of inflation data, which shows only a limited pass-through of high energy costs to other goods and services, and suggests no second-round effect on wages, Dolenc, Slovenia's central bank chief, said in an interview.

The ECB has raised its deposit rate twice this year to 2.5% as inflation jumped to nearly twice its 2% target last month and policymakers are now scrutinising the data to determine just how much more tightening is needed to prevent an Iran-war induced energy cost surge from getting embedded.

"Persistently elevated inflation that we see in our September projection and the lack of resolution of conflicts in the Middle East, Ukraine and elsewhere, supports the case for moving policy rates towards a more restrictive territory," Dolenc said. "But when and by how much we will determine on a meeting-by-meeting basis, based on the incoming data."

While last month's 3.8% inflation reading was above expectations, it was largely driven by energy, a volatile indicator, and underlying figures pointed to a more comforting trend.

"Core inflation has remained relatively stable, suggesting limited pass-through to underlying inflation components, particularly services," Dolenc said. "A more stable behaviour of core inflation provides some reassurance that broader inflationary pressures remain contained."

RISKS SKEWED TOWARDS HIGHER INFLATION

Still, risks are skewed towards higher price readings, he argued.

Energy prices could still go higher while low natural gas storage levels in the run-up to the winter are a worry, since any jump in wholesale gas prices gets transmitted to retail prices more quickly, Dolenc said.

Food prices could also rise on the combination of high input costs, droughts and El Niño, and even the euro zone's unexpectedly strong economic performance is a potential inflationary risk.

The energy price surge was expected to wipe out most of the bloc's growth this year but the economy is showing the sort of resilience seen in previous crises and it grew at its quickest rate in four years in the second quarter, well above its potential.

Since much of this was driven by personal consumption and services spending, the solid performance is likely to persist, as suggested by survey indicators, Dolenc said.

A key growth risk may be the recent rise in longer-term borrowing costs and ECB board members Philip Lane and Isabel Schnabel have both warned that the jump in yields could hold back the economy more than predicted.

Financial analysts are especially worried about the rising premium investors demand to hold French debt and some are discussing whether the ECB would intervene in markets.

Dampening those expectations, Dolenc said monetary policy continues to be transmitted to the economy efficiently.

"Monetary policy is transmitted more or less homogeneously into broader financial conditions all over the euro area," he said. "We haven't seen any destructive effect of rising yields on other parts of the economy."

For a highlight of Dolenc's quotes, click here.

(Reporting by Balazs Koranyi, Editing by Louise Heavens)