(This story is filed without a dateline to protect anonymity of sources)

July 31 (Reuters) - The European Central Bank will raise interest rates again despite faltering economic growth if inflation continues to climb or inflation expectations pick up, euro zone central bank officials told Reuters.

However, others said inflation should ease as global oil prices have fallen from record highs earlier in July.

Central bank sources said it was possible the euro zone economy would contract in the second quarter and the outlook for the rest of the year was uncertain.

But officials, who spoke to Reuters over the last 10 days on the condition of anonymity, said the ECB would raise rates from the current 4.25 percent if dangers to inflation -- which hit a fresh record high of 4.1 percent in July -- increased.

“The ECB is focused on inflation and that will determine rate policy. If inflation continues to rise, or inflation expectations pick up again, they will raise interest rates again, even if the economy were contracting,” one senior euro zone central bank source said.

Still, a second senior euro zone monetary official saw a rate increase as unlikely, as long as the fall in oil prices in the last three weeks had its expected effect in dampening inflation.

The ECB raised interest rates by a quarter percentage point to a near seven-year high on July 3. But it gave no hints of further tightening and the vast majority of economists polled by Reuters expect rates to remain on hold well into 2009. (For details of poll please double click on [ECB/INT])

“Despite the latest increase (in inflation in July) oil prices have fallen. That has to have an impact on inflation,” the second source said. “The timing is very difficult. If rates are raised the ECB must take into account the fact that the economy is already weakening, and (the rate rise) will only make itself felt in 12 months or so.”

“I see no chance of an interest rate rise before September at least. We have to wait and see if lower oil and commodity prices do translate as expected into lower inflation.”

In the Reuters poll only 17 of 85 economists said ECB rates would rise to 4.5 percent or higher by the end of the year and just three expected the ECB to reverse its July rise by that time.

Another euro zone central bank official dismissed the prospect of a rate cut and said monetary policy was still stimulating the economy. With inflation of 4.1 percent, rates of 4.25 percent are close to zero in real terms.

“In the current environment there is no need to think about cutting interest rates,” this official said. “Current monetary policy is not restrictive, rather expansive.”

GROWTH SLOWING, INFLATION PEAKING

Policymakers have said the ECB is not precommitted to any course of action as it assesses the impact of continuing credit market tensions on growth. It is also considering the risk that high inflation rates will become entrenched in the economy through higher inflation expectations, prompting workers to demand big wage rises and firms to jack up prices.

Discussions with central bank insiders made it clear that the case for raising rates is dependent on evidence of growing second-round inflation pressures, to the extent that a slowdown in growth would not dampen inflation. Several of the sources said there were few signs of a wage-price spiral to date.

Market inflation expectations over 4-7 years, gauged by index-linked bond yields, have eased back to 2.3 percent from as much as 2.77 percent a month ago INFLATION01.

The latest European Commission survey showed consumer inflation expectations also softened slightly in July while economic sentiment skidded to its lowest since March 2003, bolstering forecasts for a downturn in growth.

The Commission’s economic sentiment indicator fell to 89.5 points in July from a downwardly revised 94.8 in June.

Central bank sources said it was possible that the euro zone economy would contracting in the second quarter after a strong start to 2008. But they were divided over the odds of a contraction continuing into the third quarter, which would mean a technical recession.

“The probability of a contraction in the second quarter has increased,” said the third official, who backed ECB staff forecasts for growth of 1.5-2.1 percent this year and 1.0-2.0 percent in 2009, saying a recession was not on the cards.

However, a senior source said a recession was possible in Q2 and Q3, or at least very little growth, “and we always said that a recovery in Q4 depended on certain conditions taking place”.

“People understandably focus on the mid-pont of our forecasts but the weight of probability can be on the downside of the mid-point forecast. What is sure is that 2009 growth in the euro zone will be lower than 2008,” the senior source said.

Another senior source said predicting the outcome for Q3 was “like reading tea leaves”.

Officials said inflation was likely to have peaked in July, or would do so in August at the latest. They noted the fall in oil prices and that food costs had also softened.

U.S. benchmark crude prices CLc1 fell from a high around $147 a barrel on July 11 to near $120 on Thursday, but have since risen back to $127.

Analysts are beginning to review their calls on the price of oil. Deutsche Bank analysts published a report on Thursday forecasting a fall to $100 a barrel by the first quarter next year and towards $85 by early 2010.

Slower growth could make it harder for workers to demand higher wages and firms to pass on high input costs to their customers, but there were so far few signs of high inflation feeding into a wage-price spiral.

Still, inflation would remain above the ECB’s 2 percent ceiling for at least a year. “From autumn a certain relaxation in inflation can be expected. But we will only fall under 2 percent in the second half of 2009 at the earliest,” one official said.