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Preview: Upswing fuels talk of higher interest rates

The European Central Bank is meeting Thursday with Europe's solid economic pick-up triggering renewed speculation about the ECB's plans for raising borrowing costs.

After hiking its benchmark refinancing rate by 25 basis points to 3.75% last month, the notoriously cautious European Central Bank's 19-head rate-setting council is not expected to raise the cost of money when it meets in Frankfurt on Thursday. However, as recently last week, ECB chief Jean-Claude Trichet signaled that the bank was planning to hike rates again by repeating comments he made at his regular press conference last month declaring the 13-member eurozone's monetary policy to be 'moderate' and 'accommodative.' Trichet's comments were widely seen as setting the stage for the ECB to deliver in June its eighth rise in borrowing costs since it launched its current rate-hiking in December 2005, raising its benchmark refinancing rate by 25-basis to 4.0% and possibly taking rates to their peak. The widely predicted increase in June will coincide with the release of the ECB's latest economic growth and inflation forecasts, which will be set out as part of the bank's so-called economic projections. But the publication of a slew of forecast-beating eurozone economic data and ECB warnings about the threat of renewed inflationary pressures have meant that a growing number of analysts are not ruling out that the bank will go further, possibly pushing rates up to 4.25% or to 4.5% by 2008.

The euro gained against both the dollar and the yen in trading ahead of Thursday's meeting with the common currency climbing to ¥160.02 and edging up by 0.7% towards the critical 1.35 mark against the greenback. In particular, a batch of better-than-forecast economic data and economic sentiment surveys from Germany has helped to allay fears that January's hefty rise in the country's value-added tax combined with a slowing US economy and a strong euro would undercut growth in Europe's biggest economy. „An expected slowdown in the economy following the German VAT increase has not occurred,” said Bank of America chief European economist Holger Schmieding. „Therefore, interest rates in the eurozone will rise more strongly than previously thought.” As a result, rather than the ECB's interest-rate decision on Thursday, the financial markets' focus will again be firmly on Trichet's remarks at his press conference for hints as to whether the bank is toughening its stance on monetary policy.

Recent figures have shown new positive economic signs from France, thus easing concerns about the outlook for the eurozone's second biggest economy, which has trailed behind other parts of Europe. Figures released in the run-up to Thursday's ECB meeting showed French industrial production rising by a bigger-than-forecast 1.1% in February. This came in the wake of stronger-than-forecast production, industrial orders, exports and jobless figures from Germany amid signs that Europe's economy has managed to decouple itself from the economic risks, which are haunting the US. The eurozone emerged in 2006 from a protracted period of stagnation to grow by a solid 2.6% last year.

The ECB expects the economy built around the currency bloc to grow by about 2.5% this year and 2.4% in 2008. Meanwhile, the broad measure of the money supply (M3) which gauges the amount of money in circulation and which the ECB considers to be a key determinate of future inflationary trends has continued to hit record levels. Moreover, while eurozone inflation came in at 1.9% in March and within the ECB's 2% target for inflation of „below but close” to 2.0%, the bank has been warning that last year's record oil prices and current economic upswing could fuel big pay settlements. Germany's biggest industrial union IG Metall, which sets the benchmark for pay settlements across the nation, has already demanded a 6.5% wage rise this year. (