``We have certainly downside risks to economic activity,'' Mersch, 58, said in an interview at his office in Luxembourg yesterday. While inflation risks have also risen, ``we're not unaware of mitigation to price developments,'' he said, citing a stronger euro, near-record oil prices, the slowing U.S. economy and higher credit costs.
The ECB has threatened to raise interest rates as unions demand wage increases to compensate for the fastest inflation in six years. At the same time, the U.S. Federal Reserve is cutting borrowing costs to stave off recession in the world's largest economy after its housing market slumped.
``I don't like assumptions that what's happening in one part of the world is also true for another part,'' Mersch said. The ECB should nevertheless ``be cautious, look at the figures and take the appropriate decisions. There's still widespread uncertainty, and that's affecting confidence.''
The euro fell more than a cent on the comments, to $1.4652 at 5.06 p.m. in Frankfurt, and bonds rallied.
Mersch is the fifth policy maker this week to note either downside risks to the economic outlook or the temporary nature of the jump in inflation.
`Look Through'
The ECB can afford to ignore an oil-driven surge in inflation if it doesn't inflate wage settlements, Mersch said. ``If there's no pass-through of these temporary factors to the general price level, we're able to look through if need be.''
Inflation, which held at 3.1 percent in December, may return to the ECB's 2 percent limit next year if oil prices ease and wages don't rise excessively, ECB council members Michael Bonello, Lorenzo Bini Smaghi and Axel Weber all said this week.
Mersch said while rising oil and food costs have increased the likelihood of so-called second-round effects materializing, they ``haven't materialized so far.'' Financial-market uncertainty and ``other international developments'' may ``weigh on the inflation development,'' he said.
