ECB's Visco says rate hikes must be gradual

By Valentina Za and Stefano Bernabei

ROME (Reuters) -The European Central Bank should proceed gradually in raising interest rates, and keep a flexible approach so as to prevent financing conditions from diverging across euro zone countries, ECB policymaker Ignazio Visco said on Tuesday.

Euro zone inflation rose more than expected to yet another record high in May, strengthening the case for a more aggressive tightening cycle as the ECB debates the pace of increases.

ECB Chief Economist Philip Lane has described a 25 basis point rate hike as the "benchmark pace" the central bank should keep.

But Slovakia's central banker Peter Kazimir told Reuters he was open to discussing a 50 basis point increase, possibly in September after a quarter point rise in July, with Tuesday's data cementing the need for a rate increase.

Visco also said it was time to leave behind negative official rates, now that deflation was no longer a threat and the hit from the pandemic to aggregate demand had faded.

However, the many question marks hanging over the euro area's economic prospects warrant caution in the policy switch, he said in the text of a speech prepared for the Italian central bank's annual general meeting.

"Given the uncertainty of the economic outlook, the rates will have to be raised gradually," the Bank of Italy governor and ECB governing council member said.

In addition, Bank of Spain Governor Pablo Hernandez de Cos on Tuesday warned about the high uncertainty the ECB faced and said it was not a good idea to pre-commit to any specific interest rate path.

Visco said flexibility in conducting asset purchases had played a crucial role in allowing the ECB to counter market tensions during the pandemic.

"It remains a key element in our strategy in the event that malfunctions in the monetary transmission mechanism risk compromising the pursuit of price stability," he said.

Visco called for the ECB to pay "attention ... to ensuring that the monetary policy normalization process takes place in an orderly manner and to preventing the emergence of any market fragmentation that is not justified by economic fundamentals."

(Reporting by Valentina Za, Gavin Jones and Stefano Bernabei; Editing by Agnieszka Flak, Catherine Evans and Jonathan Oatis)