* Weber still sees 1 pct as lowest for refi rate
* Weber: euro zone economy may keep shrinking in H1 2010
* Mersch says low rates problematic
* Bini Smaghi says ECB would cut rates to zero if needed
* Bini Smaghi, Weber don't see deflation threat at present (Adds Mersch, Orphanides, detail)
By Krista Hughes and Michele Sinner
FRANKFURT/LUXEMBOURG, March 10 (Reuters) - European Central Bank policy-makers said on Tuesday interest rates could fall from already record-low levels as they warned of a persistent recession, but said lower rates could bring problems.
ECB Governing Council Yves Mersch said the economic situation is very bad and the central bank could lower rates, though that would not be unproblematic.
"We in theory could lower interest rates further," Mersch said. "But our intention is certainly to keep monetary policy effective ... I am a little sceptical of excessively low interest rates."
Fellow Council member Axel Weber said the euro zone economy could remain in recession into the first half of next year, but stuck with his aversion of zero rates.
"I see 1 percent as the bottom limit, to which the main refinancing rate should fall," he said. [ID:nLA680871]
The ECB cut rates to a record low of 1.5 percent last week and has signalled it is prepared to go lower still, but most ECB policymakers have seemed reluctant to follow other leading central banks such as the U.S. Federal Reserve and the Bank of Japan by cutting rates as low as possible.
Executive Board member Lorenzo Bini Smaghi suggested, however, the ECB could cut rates to zero, if warranted by persistently falling prices. "If the situation worsens, the ECB is ready to reduce rates further, even to zero," he said in an interview with German business paper Boersen-Zeitung.
"That is above all the case if the economy was really threatened by sustained deflation. And in such a situation, the best approach would be to act sooner rather than later."
But he said he did not see deflation taking hold. "The data that we have, including market expectations derived from the yield curve, do not suggest sustained deflation in the euro zone," he said.
Weber and Mersch delivered a similar message, saying while inflation may be negative for a few months this summer, it would not amount to deflation. And Cyprus' Athanasios Orphanides said the central bank should ensure inflation stays close to 2 percent.
DEPOSIT RATE DEBATE
Analysts see the ECB's overnight deposit rate, which is 100 basis points below the main rate, as the more important now as it steers all-important money market rates that typically determine borrowing rates for consumers and businesses.
Weber said the ECB's actions had helped to bring money market interest rates to very low levels. But even though he was prepared for the bank's benchmark to drop to 1 percent, he did not want the deposit rate to track it.
"I definitely see a problem in reducing the deposit rate to zero. I would prefer leaving this deposit rate at 0.5 percent," he said.
In an interview with Reuters TV, he said that "what will determine the floor for our rates is our deposit rate."
"I expect EONIA
Bini Smaghi raised the prospect that euro zone rates could remain low for a lengthy period, whereas Weber and Executive Board Member Juergen Stark have called for quick increases once the economic situation improves sufficiently.
It would not help the economy to cut rates to very low levels only to raise them again quickly as the economy recovers, said Bini Smaghi. Keeping them low for a long time may be more effective in encouraging investors to invest long-term.
INTEREST RATE ALTERNATIVES
Weber and Bini Smaghi both struck a cautious note on how to boost the economy via measures in addition to interest rates. Irish ECB policymaker John Hurley added to the debate, telling a parliamentary committee he was in favour of exploring all the available options. [ID:WLA9387]
Speculation has grown that the ECB will have to switch to unconventional tactics such as buying bonds, something the Fed and Bank of England are already pursuing. But Bini Smaghi said such a move could raise problems and go against the ethos that forged the currency union.
"If the ECB bought government bonds on the secondary market, that would be getting close to fiscal policy. ... And that would not be in the spirit of the ECB's founders," he said.
Weber said that while the ECB was weighing its options, it had to tread carefully. "We have to make sure that any actions that we take are against EU treaties, especially that we would not start any prohibited state financing," he said.
Mersch said any non-traditional measures should not bypass the banking system, as this would come close to offering fiscal assistance and could jeopardise central bank independence. (Reporting by Marc Jones and Krista Hughes in Frankfurt, Michele Sinner in Luxembourg and Michele Kambas in Limassol; Editing by David Stamp/Victoria Main/Leslie Adler)