ECB's Draghi faces heat over euro, Monte Paschi

FRANKFURT (Reuters) - Mario Draghi faces a grilling over the European Central Bank's sensitivity to the euro's sharp rise and his connection to an Italian banking scandal on Thursday, at a monthly meeting when the ECB is almost certain to hold interest rates unchanged.

Investors will seek to gauge how much further the euro must rise before its strength forces the ECB to express concern, or even reverse course and contemplate a rate cut - a scenario that shows next-to-no sign of materializing on Thursday.

The euro has appreciated to a 14-month peak against the dollar this year, though it slipped on Wednesday, with traders becoming cautious in the event that Draghi expresses concern about the currency's strength.

The ECB's policymakers meet after French President Francois Hollande said on Tuesday the euro zone must develop an exchange rate policy to protect the currency from "irrational movements".

Erkki Liikanen, an ECB Governing Council member, later dismissed any prospect of the bank pursuing such a policy, saying "we have no foreign exchange target" - a line ECB chief Draghi is likely to take at his 1330 GMT news conference.

"The market will want to hear stronger words on the foreign exchange front to stop the upwards trend that's in place but we doubt this will happen," said Nomura economist Nick Matthews.

"I think he will focus more the comments around the exchange rate on the G20."

At his news conference last month, Draghi read out a G20 statement on exchange rates. The G20 group of economic powers holds a mid-February meeting and France said on Wednesday it would raise concerns about the euro's strength then and at talks among euro zone finance ministers next Monday.

BANK SCANDAL

At Thursday's news conference, Draghi can also expect to be asked how much he knew about the derivatives scandal at Siena's Monte Paschi bank, and what he did about it when he headed Italy's central bank from 2006 to 2011.

Italy's third largest bank has been at the centre of a financial and political storm as a result of facing losses of about 1 billion euros from a series of derivatives and structured finance trades.

Draghi's news conference offers reporters their first chance to quiz him directly on the Monte Paschi scandal since his role came into focus late last month.

Draghi faced criticism then after former Italian economy minister Giulio Tremonti said it was "stupefying" that in his role as supervisor of Italy's banking system Draghi failed to discover or prevent loss-making derivatives trades at the bank.

Monetary policy should prove easier for Draghi to handle.

None of the 75 economists surveyed in a Reuters poll last week forecast a cut in rates from their record low of 0.75 percent on Thursday. The poll suggested the ECB would not change its rates until at least July 2014.

A batch of indicators cited by Draghi at his January 10 news conference show the economic distortions of the euro zone debt crisis are starting to correct themselves, with the data flow positive over the last month.

One of the indicators shows the ECB's balance sheet shrinking after banks jumped at the chance late last month to repay early 137 billion euros in long-term loans they took from the central bank.

This market-driven unwinding of ECB crisis funding measures is in stark contrast to the expansionary policies being pursued in the United States and Japan.

(Writing by Paul Carrel; Editing by Giles Elgood)