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By Sakari Suoninen
HELSINKI (Reuters) - The European Central Bank keeps a close eye on the euro exchange rate to see how it affects inflation, and it stands ready to act if the inflation rate appears headed in the wrong direction, ECB Governing Council member Erkki Liikanen said on Monday.
The euro's exchange rate is not an ECB policy target, but it has become increasingly relevant in the central bank's economic assessment. A stronger euro could hamper the 28-country bloc's recovery and weigh on already-low inflation.
"We look at foreign exchange as much as it has an impact on inflation," Liikanen, who is also governor of Finland's central bank, said at the presentation of its quarterly bulletin.
Liikanen called inflation pressures "moderate" and said the ECB was "ready to take further decisive action" if needed.
Euro zone inflation stood at 0.7 percent in February, far below the ECB's target for close to but below 2 percent. The ECB expects inflation to rise slowly over the next couple of years to 1.5 percent in 2016 and it sees only limited deflation risks.
Asked whether the ECB should ease policy further, Liikanen stressed the ECB's easing bias. The bank's forward guidance says it will keep rates low or even lower for an extended period.
"We assess the situation in each meeting," he said. "One has to remember that we have a clear downward bias ... we have also added to our communication the unused capacity in the economy, and that monetary policy will remain accommodative well into recovery. All this has made our communication very strong."
The ECB kept interest rates at a record-low 0.25 percent at its March policy meeting and took no other measure to stimulate the economy. That disappointed markets and pushed the euro to a 2 1/2-year high against the dollar.
Liikanen said it would be good to use a longer perspective than just last month when looking at the exchange rate.
"Interest rate differentials between German and U.S. bonds have increased. Another factor which I believe could have an impact on the U.S. economy and also foreign exchange rate on a long-term perspective is that growth there seems to be stronger," he said.
The Bank of Finland said in its report the period of low inflation may be longer than previously expected.
The outlook for the global economy had improved slightly, Liikanen said. But he added that risks were on the downside, especially in the short term because of the crisis in Crimea.
At the same time, financial-market confidence and bank funding conditions had improved. The ECB's health check of the bloc's largest lenders should provide an additional boost to confidence, Liikanen said, though it was too early to sound an all-clear.
As for his native country, Liikanen said Finland was going through a serious structural crisis, and that the Crimean crisis would have ripple effects on the already-weak economy.
"The fragility of the Russian economy - made worse by the situation in Ukraine - and the contraction in foreign trade will also weaken the Finnish economy," he said.
The Bank of Finland cut its growth forecast for Russia to 0.5 percent, saying that the crisis would slow Russian growth for at least all this year, even if tension subsided quickly.
(Reporting by Sakari Suoninen; Editing by Larry King)