Rise in EU inflation may lift interest rates

Rising inflation across the euro zone will compound pressure on the European Central Bank (ECB) to raise rates over the coming weeks.

Overall euro zone inflation was running at 2 per cent in January with Ireland topping the league at 4.4 per cent and the Netherlands and Austria at 1.6 per cent, according to figures released yesterday by Eurostat.

The 2 per cent rate, which is at the top end of the ECB's permitted range, was underlined by news that German inflation rose 0.4 per cent in February to bring it to an annual rate of 1.8 per cent.

This combination provides the ECB with all the excuses it needs to increase interest rates at its next meeting tomorrow. However, according to Mr Jim Power, chief economist at Bank of Ireland, the executive board is more likely to wait for the meeting in Madrid on March 30th to raise interest rates to 3.5 per cent from 3.25 per cent.

Not waiting could produce a negative reaction if the markets believed that the rise could knock back growth prospects. Although much of the inflationary surge is the result of rising oil prices, the ECB is thought to be keen to bring rates back to what it would call a more normal position at around 4 per cent by the end of the year.

Tomorrow's decision will also depend on the behaviour of the euro in the intervening period. Late yesterday the euro currency was calm after pushing upwards earlier in the day following a rumour that the Bundesbank had finally decided to intervene in its support.

If volatility was to increase again and the currency was to fall as it did earlier this week it would almost certainly rule out a rate rise, according to Mr Power.

The euro closed at $0.9636 from $0.9679 and at 60.98p against sterling from 60.83p a day earlier. As a result the pound closed at 77.42p from 77.24p.

And in a piece of potential good news for Irish importers, sterling came under pressure against the dollar following a number of comments from members of the Monetary Policy Committee. The governor of the Bank of England, Mr Eddie George, described sterling as significantly overvalued and said its current levels were unsustainable.