* Stark sees risks of new excesses emerging
* Sees negative side effects if have rates too low, too long
(Adds fresh quotes)
By Paul Carrel and Dave Graham
BERLIN, Sept 15 (Reuters) - The European Central Bank might have to raise its interest rates before troubles in the money markets have fully subsided, ECB Executive Board member Juergen Stark said on Tuesday. Stark said a recent improvement in economic data suggested the euro zone could pull itself out of recession this quarter, earlier than expected.
But he added that a high degree of uncertainty remained about the economic outlook and that the bank may face the tricky situation of having to hike interest rates before unwinding the special financing measures it has put in place to help money markets and banks through the crisis.
"A scenario cannot be entirely ruled out where upside risks to price stability emerge while the problems in money markets persist," Stark said in the text of a speech at the Canadian Embassy in Berlin.
"We might then have to maintain the structure and size of our balance sheet. But, at the same time, we would have to raise interest rates to counter upside risks to price stability."
The ECB would focus squarely on inflation and should not let lingering worries about the health of banks interfere with its thinking, he added.
"As soon as upside risks to price stability emerge, and with a view to avoid contributing to the emergence of another asset price bubble, we would have to act accordingly," he said.
Stark later added that there were risks to keeping rates low for too long: "There are many potential negative side effects in the case that we keep interest rates too low for too long."
Stark said the biggest problem central banks and governments face is getting the timing right for withdrawing support measures.
Governments should develop and communicate exit strategies as soon as possible and start them no later than economic recovery, he noted.
"Unwinding fiscal stimuli, while necessary, is clearly insufficient to restore sustainable public finances," Stark said. "The structural adjustment of fiscal policies to the new economic environment will be needed."
RISK OF NEW EXCESSES
Stark said low interest rates around the world meant there was a risk of new excesses and price bubbles emerging.
"I'm concerned about these developments," he said in a question and answer session after his speech.
"We have to strike the right balance...in due time not to allow the emergence of asset price bubbles," he said, adding that to withdraw fiscal stimulus and liquidity too early would lead to a collapse in the banking system.
He echoed other policymakers in stressing that now was not the time to put exit strategies in motion. But keeping support measures in place for too long could create problems.
"Both central bank and fiscal measures may contribute to weaken the incentives for banks to clear troubled assets from their balance sheets and to monitor their credit risk carefully," he said.
"Very low interest rates can also hamper the functioning of the money market: The lower money market interest rates are, the lower the incentive for banks to trade funds in the market."
Stark said he also saw a risk of budget deficits getting out of control.
"I doubt whether in the euro area... there is really the political will to reduce deficits," he said.
For a copy of the speech, please see the Web site: http://www.ecb.int/press/key/date/2009/html/sp090915.en.html (Reporting by Paul Carrel and Dave Graham, Writing by Marc Jones; Editing by Ruth Pitchford)