Low interest rates in the 12-nation region are driving dynamic growth in money supply and credit, and these inflationary risks are greater than a year ago, ECB Governing Council member Axel Weber of Germany said.
"We see not only price risks from our economic analysis because of oil prices, but also from the monetary analysis," he told reporters after addressing a monetary conference hosted by the Bundesbank, which he heads.
In Helsinki, ECB Governing Council member Erkki Liikanen said rising energy costs create a significant risk to long-term inflationary expectations, although currently those expectations remain under control.
Their warnings added to a stream of cautionary comments in the past week from ECB policymakers, who have put markets on heightened alert for the first ECB rate rise in five years. The ECB's key rate has been at 2.0 percent since June 2003.
While they are not saying the ECB will raise rates at its meeting next Thursday, they have left no doubt that they are watching very closely for any sign that high oil and fast money growth is feeding a broader price spiral.
"Due to rising prices of oil and gasoline, short-term inflationary expectations have been revised upward. Still, long-term inflationary pressures in the euro area are under control," said Liikanen, who heads the Finnish central bank. "But significant risks to their upside need to be taken into account."
Money supply grew at an 8.2 percent 12-month rate in August, compared with the ECB's 4.5 percent reference rate, and analysts are forecasting that fresh M3 data due on Friday will show similar strength. A year ago, cautious investors were hording cash and money piled up in current and savings accounts.
Weber said this no longer can explain the money supply growth, and it is proven as a driving factor in inflation after eight quarters.
"We see now an increasing dynamism which is less explicable by portfolio shifts and increasingly driven by low interest rates," he told reporters. "An increasing part of liquidity has clear implications for risks to price stability over the medium to long term."
The ECB is determined to keep inflation expectations well anchored and make sure that short-term changes in the price of crude oil do not destabilise the price outlook, Liikanen said.
Oil has doubled in price since 2003 and risen roughly 25 percent this year alone. Central bankers world-wide worry that the longer energy prices remain high and keep rising, the more likely it is that workers will demand higher wages and companies will raise prices - creating second-round inflationary effects.
ECB chief economist Otmar Issing has said there are already scattered signs of second-round effects and it looks increasingly likely consumer inflation may not fall below 2 percent next year.
Weber noted that cheap credit which is driving strong loan demand particularly in the housing market can have a follow-through impact on inflation. "An investor, who does not buy real estate for personal use, will want higher rent when prices go up. There's a clear link between real estate prices and rent, and rent plays a role in the consumer price index," he said.
Updated data on consumer prices, which accelerated by 2.6 percent year-on-year in September, are also due for release on Friday.
Analysts expect more strong data. Weber has said that inflation may stay above the ECB's 2 percent ceiling until late 2006. Such a development could prompt the ECB to raise its 2 percent refinancing rate sooner rather than later, some economists say.
Liikanen said in his speech to a finance seminar that both the ECB's tools for monitoring inflationary risks - analysis of the real economy and the supply of money and credit - are flashing significant warning signs.
"Comparing both these pillars shows that vigilance in monetary policy must be stronger than before so that inflationary expectations can be kept in line with price stability," he said.
What has confused financial markets, however, is whether this aggressive language of "strong vigilance" signals that the ECB is preparing to raise rates soon, or whether the comments are primarily aimed at reminding employers and workers that they need not raise costs for fear inflation accelerate longer term.
December Euribor contracts priced a 50-60 percent chance of an ECB rate hike by year end after Weber said on Tuesday the central bank stood ready to act if needed, a message he repeated in Munich on Wednesday.
But a Reuters poll showed economists more sanguine. They forecast on average an ECB rate hike by mid 2006.