ECB's inflation fears linger despite oil price retreat

SINTRA, Portugal, June 30 (Reuters) - European Central Bank policymakers welcomed the recent drop in oil prices on Tuesday but warned that energy costs remain high and the shock will linger in the economy for some time, fuelling price pressures.

The ECB raised interest rates last month and policymakers are contemplating whether to follow that with further monetary tightening in the coming months, even if prospects for a Middle East peace deal have driven oil prices lower since the June 11 rates decision.

Another move is already priced in by markets and remains firmly on the table.

"In terms of the overall inflation impulse, the fact that we do have, maybe for a couple of years, oil prices above the pre-war level, that essentially is a cost-increasing impulse to the economy," the ECB's chief economist, Philip Lane, said on Bloomberg TV.

Bundesbank President Joachim Nagel acknowledged that energy prices fell quicker than the ECB had projected, easing some price pressures.

The ECB's milder scenario had projected that Brent crude prices would drop to $78 a barrel by the end of the year, but it is already below $73 and futures hint at further falls to come.

"I have to admit that the retreat of energy prices, oil prices, this was a surprise," Nagel told CNBC.

However, both Nagel and Lane warned that supply constraints and the need to replenish oil stocks could keep prices relatively high for some time.

"The energy price shock that started with the conflict in the Middle East is not over, is still in the system, so I expect inflation rates will stay significantly above our target," Nagel said. 

Belgian central bank chief Pierre Wunsch, meanwhile, said the case for another rate increase has diminished.

"We might need another hike — that’s, of course, what the market is pricing — but not as much as we thought in June," he told Bloomberg TV. "I would rather, if we believe we need another one, move quickly. It doesn’t mean July."

Financial markets put the chance of a July rate increase at about 33% and a move is fully priced in only by December. 

(Reporting by Balazs KoranyiEditing by Andrew Heavens and David Goodman)