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ECB must battle low inflation expectations, Rehn says

HELSINKI, Oct 3 (Reuters) - The European Central Bank must react strongly when inflation expectations are too low to stop them from getting stuck at unacceptable levels, Finnish policymaker Olli Rehn said on Thursday, defending the bank's decision to raise stimulus.

The ECB eased policy further last month to lift growth and inflation, a divisive decision which has sparked an unusual public spat between the majority doves and more conservative policymakers from the north of the euro zone.

Rehn, who has long backed outgoing ECB chief Mario Draghi's policy, argued that if the ECB accepted low inflation, it would constrain its own ability to steer the economy through business cycles.

"We should take care to avoid the sort of harmful equilibrium that arises from prolonged low inflation and zero interest rates, as this would significantly constrain the capacity for monetary policy to balance the economic cycle," Rehn said in prepared remarks.

"This would bring about a lengthy shortfall in economic growth with respect to its potential and hinder efforts to boost employment," he added.

The ECB aims for inflation at just below 2 percent, but it has undershot that target since 2013. Its projections show it has little hope of reaching it for years to come.

Markets' inflation outlook initially rose on the September stimulus pledge, but they have now fallen on expectations growth will slow further.

Pointing to the experiences of Japan, Rehn argued that once inflation expectations remain too low for too long, they risk becoming permanent, leading to low price growth. That would limit the central bank's ability to ease policy. (Reporting by Anne Kauranen, writing by Balazs Koranyi, editing by Larry King)