By Valentina Za and Andrea Mandala
MILAN (Reuters) -The European Central Bank (ECB) can take a cautious approach to raising interest rates given that short-term inflation expectations have dropped sharply and longer-term ones remain under control, a top Italian policymaker said on Saturday.
ECB Governing Council member Ignazio Visco, who is also the Bank of Italy's governor, warned an excessive tightening of policy would have "serious implications" for economic activity and financial stability.
He reiterated he saw this as a risk that carried the same weight as a too gradual tightening when it came to balancing rate decisions.
The ECB this week raised its key rate by 50 basis points to 2.5% and said it would replicate the move in March.
"The policy tightening can now continue with the due caution, carefully assessing the implications for the economy and inflation prospects of the measures that have already been adopted," Visco told the annual conference of Italy's Assiom-Forex financial markets association.
The ECB has kept its options open about subsequent steps after March, raising doubts among investors about the extent of further increases.
Investors and economists have focused on a peak in the deposit rate of between 3.25% and 3.5%, which suggests just one or two moves after the March hike and an end by mid-year.
Politicians in Italy have expressed concerns about the impact of rising interest rates given the country's huge debts.
LOAN WRITEDOWN FEARS
In the text of his speech on Saturday, Visco said the bulk of corporate debts in Italy paid a floating interest rate, which exposed companies to the increase in borrowing costs.
"Looking ahead, a significant increase in loan writedowns cannot be ruled out: ... they could rise, in relation to total loans, from less than half a percentage point to nearly one point this year and in 2024," he said, adding that was still half the peak reached in 2013-2014.
For now, however, new inflows of impaired loans remained low at around 1% of total lending.
Banking supervisors are specifically monitoring credit risks, as well as liquidity and refinancing risks, Visco said, adding there was a danger that higher rates fed into banks' funding costs more rapidly than in the past.
Supervisors have asked banks to submit their refinancing plans, also in light of the need to replace longer-term 'TLTRO' funds banks have borrowed from the ECB and are gradually repaying, Visco said.
In this respect, Italian banks intend to tap markets and boost deposits to get alternative funds, Visco said, while also planning to use excess reserves deposited with the ECB and the sale of liquid assets to repay the TLTRO money.