* Stark says ECB to reverse low rates as economy picks up
* Euro zone economy no longer in free-fall
* Governments should seek exit strategies from stimulus
* Govt bond yields may rise further as economy recovers (Adds comment to reporters)
By Eva Komarek
LINZ, Austria, June 8 (Reuters) - The European Central Bank will reverse its very low interest rate policy once the economy starts to recover and price pressures reemerge, Executive Board member Juergen Stark said on Monday.
Stark said the ECB's focus on ensuring stable prices would not waver, and it was clear the central bank could not keep up its current level of support forever, noting the economy was no longer in "free fall."
"Maintaining price stability will remain the only objective that guides our decisions," he said in a speech at an Austrian Industrial Organisation event.
"This implies that the very accommodative monetary policy stance we are pursuing now will be reversed once the economy starts to recover and upside risks to price stability emerge again."
Stark's comments underline the resistance among some at the ECB toward taking rates any lower than the current record low of 1 percent and are the most explicit to date about the triggers for future rate hikes.
Most economists polled by Reuters forecast unchanged rates through 2010, and the International Monetary Fund said on Monday ECB should consider further cuts as soon as possible. For more click on [ECB/INT] and [ID:nWEA6001].
The ECB expects the euro zone economy will start to grow again by mid-2010, although inflation is seen well below its price stability goal of below -- but close to -- 2 percent next year, reducing the scope for tightening. [ID:nL4997231]
Stark told journalists after his speech that interest rates were appropriate, even taking an expected further deterioration in labour markets into account, and played down the chance of a move in either direction any time soon.
"I do not want to and cannot discuss hypothetical scenarios," he said when asked about future rate moves, adding that the ECB saw inflation risks as balanced.
Fellow policymaker Axel Weber, speaking in France, also stressed the need for a timely exit and said the ECB would wind back its policy of lending banks unlimited funds in time to counter potential inflation risks and help avoid future financial crises.
"Should the overall economic picture improve, the Eurosystem will absorb the extra liquidity provided as quickly as possible," Weber said in Gouvieux-Chantilly. [ID:nLAG003491]
NO FREE FALL
Stark said there was evidence the euro area economy, which has contracted about 4 percent in the last two quarters, would shrink further in the second quarter, but the pace was slowing.
"The economy is no longer in free fall; we are seeing the first signs of stabilization he said.
"Indicators of consumer confidence and business sentiment have continued to improve somewhat. We are also seeing some encouraging signs of normalization in financial markets."
Stark repeated the assessment given by ECB President Jean-Claude Trichet last week that the euro zone economy would remain weak for the rest of 2009 and recover only gradually during 2010.
Quarterly growth rates would turn positive by mid-2010, he said, and inflation would remain subdued.
"Inflation rates are likely to enter negative territory during the summer, but we expect them to turn positive by the end of 2009," Stark said, noting the impact of past energy price falls.
He dismissed the chance of deflation in the 16-nation region and said the process of disinflation was "of no concern to the ECB, which aims to maintain price stability in the medium term."
Stark urged euro zone governments to avoid the temptation of extra fiscal stimulus and said they must make plans for fiscal consolidation or risk eroding public confidence.
He noted governments had not laid out a clear exit strategy from stimulus programs and said past fiscal behavior could play a role in pushing up the yields on government bonds.
"So far, most euro area countries have enjoyed relatively low interest rates on new government debt issuance, despite facing considerably more difficult market conditions," he said.
"Looking ahead, as the economy recovers and competition for financing increases, governments may face higher bond yields again."
Restructuring the banking sector should be the top policy priority and is key to economic recovery, Stark said.
The ECB supported establishing a new European Union body to consider systemic risks to the financial system, to be chaired by the ECB president, but would not use interest rates to act against risks in the banking sector.
For a copy of Stark's speech, please see: http://www.ecb.int/press/key/date/2009/html/sp090608.en.html (Additional reporting by Sakari Suoninen in Frankfurt and James Mackenzie in Gouvieux-Chantilly; Writing by Krista Hughes; Editing by Victoria Main and James Dalgleish)