Europe to raise interest rates amid strong inflation and economic mood

EUROZONE annual inflation held well above the European Central Bank’s target in July while economic sentiment surprised on the upside, cementing expectations the bank will raise interest rates on Thursday.

Inflation in the 12 countries using the euro was 2.5% year-on-year, the European Union’s statistics office estimated on Monday, unchanged from June above the 2% expectations.

Economic sentiment in the euro zone rose to 107.7 points in July from a revised 107.1 in June, the European Commission said, the strongest reading since early 2001.

This beat market expectations of a slight decline to 107.0, pointing to a strong start to the second half of the year after an investment- and export-driven rebound in the first half.

“The overall take on this seems to be very positive and going into the ECB meeting this week, nails the case for a 25-basis-point increase on Thursday,” said Kenneth Broux, economist at Lloyds TSB.

Economists expect the cost of credit to increase to 3% on Thursday, and then again by 25 basis points in October and December for a year-end figure of 3.5%.

The ECB is expected to raise rates to stem inflationary pressures from high oil prices and fast credit growth, as the euro zone economy accelerates.

Economists said headline inflation was likely fuelled by a surge in oil prices and drought, which underpinned food prices.

The ECB wants to keep inflation just below 2%, and some economists said rising sentiment and above-target inflation could quicken the pace of rate rises.

“Aside from this week’s hike, it suggests the ECB will want a slightly faster pace of rate hikes going forward, every two months rather than every three,” said Matthew Sharratt, economist at Bank of America.

Elevated consumer inflation expectations would be another cause for concern for the ECB, they said. The Commission survey showed inflation expectations among consumers were unchanged from June at 24 points, above the long-term average of 23.