ECB meets today, expected to keep euro rate steady

The European Central Bank is expected to toughen its inflationary warnings slightly at its policy meeting on Thursday to prepare the ground for another interest rate increase, probably in September.

The economy is steaming ahead at an above-trend growth rate around 2.6% due to robust global demand. Unemployment has tumbled to record lows of 7% and lending is rising at double-digit rates.

Solid growth is fast using up spare capacity in factories and labor markets, heightening the danger that inflation will accelerate. It has held below the ECB's ceiling of 2% for 10 months but ECB policymakers doubt this can last.

"No one doubts the strength of growth today is significantly higher than what we expected a year ago, so that requires us to monitor a bit more intensely because of the strength and extent of growth," said Executive Board member Jose Manuel Gonzalez-Paramo, who is viewed as a moderate.

Governing Council member Nicholas Garganas of Greece was blunter. "The danger of higher than expected euro zone inflation is visible this year," he said recently.

All 93 analysts in a Reuters survey this week forecast the ECB Council will leave rates at 4.0% on Thursday but raise them to 4.25% in September or October.

The ECB began its meeting at 0700 GMT and announces its decision at 1145 GMT, followed 45 minutes later by a news conference. Before that, the Bank of England will have announced its rate decision. It is widely expected to tighten a quarter%age point to 5.75%.

For the ECB, most analysts - 84 of 93 - expected President Jean-Claude Trichet to signal a September increase, which would leave room for another rise in December.

"Monetary growth is strong. Capacity utilization is strong. Inflation is not bending downwards. I am very confident about September," said Erik Nielsen, economist at Goldman Sachs.

Euribor contracts have fully priced for 4.25% by the year-end and have built in a two in three chance that this rate will be reached by September. European government bond futures traded lower early Thursday before the rate decisions.

In currency markets, the euro approached all-time highs against the yen and was strong against the dollar on expectations that Trichet will reinforce the market view for higher euro zone rates.

Doves want to slow tightening

Timing of a move hinges on two factors - how Trichet signals the rise given the looming summer break, and speculation that doves on the Governing Council would rather slow the pace of tightening, now rates are nearing a peak in the cycle.

"We have difficulties because of the timing of the August break, which gives the caveat it is very hard to say how they will handle this," said Sandra Petcov, European economist for Lehman Brothers.

After its June rate increase, the ECB used the wording that it will "monitor closely" the price risks ahead - a phrase usually employed when the next rise is three months away, and once when it was two months off.

If it sticks to its usual communication pattern, the ECB would strength the anti-inflationary warnings in this month's policy statement to monitoring price risks "very closely" and then say "strong vigilance" is warranted in August.

On past ECB behaviour, this would flag a September move. Trichet could also affirm market expectations for September action during this month's news conference.

For the ECB, most analysts - 84 of 93 - expected President Jean-Claude Trichet to signal a September increase, which would leave room for another rise in December.

"Monetary growth is strong. Capacity utilisation is strong. Inflation is not bending downwards. I am very confident about September," said Erik Nielsen, economist at Goldman Sachs.

Euribor contracts have fully priced for 4.25% by the year-end and have built in a two in three chance that this rate will be reached by September. European government bond futures traded lower early Thursday before the rate decisions.

In currency markets, the euro approached all-time highs against the yen and was strong against the dollar on expectations that Trichet will reinforce the market view for higher euro zone rates.