Credit Crunch: Central Bank Likely to Raise Eurozone Interest Rates Despite Downturn

The European Central Bank seems determined to raise interest rates this week, in the hope of reining in soaring inflation across the 13 member countries of the eurozone. But there are warning signs that members are facing a slowdown like the one affecting Britain.

Some countries would be particularly hard hit if the central bank raises its one-size-fits-all interest rate by a quarter point to 4.25% on Thursday - the first rise for a year.

Figures out yesterday made a rate rise all but certain after inflation jumped to a 16-year high of 4% in June, mainly as a result of higher oil prices. The increase was from 3.7% in May and was greater than financial markets had been expecting.

"If there were any remaining doubts about a [0.25 percentage point] rate hike on Thursday, they can now be put to rest," said Martin van Vliet, economist at ING Financial Markets.

Germany, Europe's biggest economy and the world's largest exporter, has been growing very robustly on the back of a sizzling global economy and has shrugged off the strength of the euro, which makes exports less competitive. But other European economies such as Ireland and Spain are in the middle of full-blown housing market meltdown.

The German economy, which grew at 1.5% in the first quarter of this year, now looks in trouble. Rising petrol prices hit consumer sentiment and business confidence has turned down. Unemployment has ticked up for the first time since March 2006 and retail sales have fallen for three months in a row. Some economists think Germany may show no growth at all in the second quarter.

"Until recently the German economy was the last glimmer of hope for the eurozone economy. The powerhouse of the eurozone economy was running strong, fueling the ECB's famous 'sound economic fundamentals'," said Carsten Brzeski, economist at ING Financial Markets.

"Now, Germany mirrors the malaise of the entire eurozone. Inflation is close to a 15-year high and a whole range of confidence indicators point to difficult times ahead."

Nevertheless, Germany goes into the slowdown with some momentum behind it. Other economies have run out of steam. The once booming Irish economy is in the middle of a housing slump which has brought it to a shuddering halt and raised talk for the first time in many years that people may again start to emigrate.

Housebuilding has plunged by two-thirds this year and employment in construction has dropped sharply. There are anecdotal reports of thousands of Polish builders heading home again.

A similar housing collapse, the result of enormous over-building in recent years and a big drop in demand, is going on in Spain. Spanish unemployment is heading rapidly towards 10% and inflation is above 5%.

France is suffering a slowdown in the housing market, with property sales down 30% this year and prices flagging. The French are panicking about the impact on purchasing power of higher food and petrol prices. Tighter credit conditions generally are undermining economic growth.

Lavinia Santovetti, economist at Lehman Brothers, said: "The euro area retained a good deal of momentum in the first quarter, with GDP expanding by 0.8% quarter-on-quarter. However, there is mounting evidence that the economy is faltering. A sharp fall in growth now looks imminent."