Eurozone Braced for Rate Rise Despite Figures Showing Dip in Inflation

Inflation in the 12-nation eurozone dropped back last month while unemployment remained high, figures showed yesterday, but analysts warned that the European Central Bank would still raise interest rates at lunchtime today.

Brussels-based Eurostat said the average inflation rate in the countries using the euro fell to 2.3% in February from 2.4% in January. Economists said the fall was due to the effect of last year’s rising oil and gas prices having worked its way through.

The ECB is concerned that inflation remains above its 2% ceiling and that strong credit growth and rising energy prices could create new inflationary pressures.

Many economists are not convinced. "Barring major surprises on the energy and food price front, we expect headline inflation to slide gradually towards 2% during the spring," said Silvia Pepino, economist at JP Morgan.

Having raised rates by a quarter point to 2.25% in December, the first rise for five years, the ECB’s governing council is expected to increase them to 2.5% today. ECB president Jean-Claude Trichet has given strong hints in recent weeks that the economic recovery in the bloc, more evident in forward-looking surveys than in hard economic data, means the ECB’s refinancing rate can be moved gradually higher to remove the boost being given to the economy by cheap money.

However, unemployment figures for February, released by Eurostat yesterday, showed there were question marks over the strength of the recovery. The statistics bureau said the unemployment rate for the zone was steady at 8.3% in January and well above Britain’s 5.1% rate.

In spite of that, and overall economic growth of 0.3% across the eurozone in the fourth quarter of 2005, the ECB is focusing on surveys such as Germany’s IFO business confidence survey, which is pointing to further recovery in the German corporate sector, even if domestic consumer spending remains subdued.

It will have gained further reassurance from yesterday’s purchasing managers’ survey of European manufacturing, which hit its highest level in 19 months and was much stronger than in Britain.

The Royal Bank of Scotland/NTC eurozone purchasing managers’ index rose to 54.5 in February as German and Italian manufacturers benefited from a continued hunger for capital goods around the world. The 50.0 level divides expansion from contraction. But recruiting intentions among European manufacturers remained below the 50 mark, where they have been for all but one of the past 57 months.

Analysts expect the ECB to continue to raise rates, with the majority predicting borrowing costs up to 3% by the summer. The ECB believes the fourth-quarter slowdown will turn out to have been temporary and that growth and employment will pick up through 2006.