March 10, 2017 / 5:50 PM / 5 months ago

UPDATE 1-ECB paving ground for very gradual tightening -sources

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FRANKFURT, March 10 (Reuters) - The European Central Bank is preparing the ground for a gradual phasing out of its aggressive stimulus measures, resisting isolated calls for more radical action from some policymakers, two sources familiar with the discussion said on Friday.

Some members of the ECB's Governing Council had raised the possibility at this week's policy meeting of raising interest rates even before bond purchases end, the sources said, confirming a Bloomberg report. The discussion was brief, however, and did not receive broad support, they added.

Euro zone inflation is rebounding but the economic outlook remains uncertain and marred by high-risk elections in France and Germany. That has left the ECB walking a tight rope between priming the market for an eventual tightening and withdrawing its safety net for the economy too soon.

Against this backdrop, the ECB is likely to stick to fine-tuning its message for the next few months and refrain from any major policy shift before the French elections in May and possibly the German vote in September, the sources said.

ECB President Mario Draghi reaffirmed on Thursday that the euro zone's central bank would first stop adding to its 2.3 trillion euro bond-buying programme and only afterwards consider any increase in its interest rates.

A rate hike would chiefly mean lowering a penalty charge that banks must pay for parking cash securely with the ECB overnight.

This extreme measure was introduced in 2014 to discourage cash hoarding and kick-start lending. It has since cost banks billions of euros, partly because of the growing amount of excess cash injected into the banking system by the ECB itself via its asset purchases.

Lending is now picking up, albeit slowly, and the damage associated with negative rates has become apparent to the ECB itself, which is also the euro zone's top bank supervisor.

Some ECB rate-setters, including Jens Weidmann, head of Germany's powerful Bundesbank, have called for the institution to at least consider ruling out any further rate cuts.

Financial markets are now fully pricing in a rate hike next year and some economists expect one even before then.

"From June on we may see some changes, such as an increase in the deposit rate," Berenberg economist Florian Hense said. (Reporting by Balazs Koranyi; Editing by Francesco Canepa and Catherine Evans)

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