Euro-zone growth fuels rate rise fears

Interest rates are set to rise further following better than expected economic growth across the euro zone in the last quarter…

Interest rates are set to rise further following better than expected economic growth across the euro zone in the last quarter of 2006.

The European Central Bank (ECB) has already signalled that interest rates will rise by a quarter point when it meets in March. However, economists say it is increasingly likely that borrowers will face a further quarter point increase in June.

And, in a move that will not be appreciated by the Government just ahead of a general election, a June rate rise would be signalled by ECB president Jean Claude Trichet in Dublin, where the ECB governing council meets on May 10th.

Euro zone gross domestic product rose 0.9 per cent in the last quarter, half as much again as forecast by analysts and well above the 0.5 point rise seen in the single-currency area in the third quarter.

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The region's gross domestic product growth hit 2.7 per cent last year, 0.1 point higher than a recent European Commission forecast, and well ahead of its target of around 2 per cent.

The GDP figures are likely to lead to an upward revision of economic forecasts across the zone and heighten worries at the ECB.

Interest rates have already risen six times since the current cycle began in December 2005.

At that time, a first-time buyer with a €250,000 tracker mortgage over a 30-year term was paying around €1,068 a month. That has now risen to €1,282 and will jump to €1,319 following next month's increase.

A further quarter point increase in June would see that monthly payment increase to €1,357 - nearly €300 a month more than just over a year ago.

And some analysts, including AIB Global Treasury's Oliver Mangan, think rates could rise further - to 4.25 per cent - by the end of the year unless the pace of growth slows dramatically. That would mean monthly payments on the mortgage outlined above of €1,396.

Growth rose ahead of expectations across the euro zone's main economies - Germany, France, Italy and Spain - in the final three months of 2006, and analysts say the momentum is likely to spill over into 2007.

"These numbers are astonishingly strong," said Austin Hughes, chief economist at IIB. "They probably mean that the European economy is a little too hot for comfort from the point of view of the ECB."

Goodbody chief economist Dermot O'Leary noted that the figures were, by their nature historic data, which usually attracted less attention.

"However, anecdotal evidence is coming through that the German economy has been unscathed by the three percentage point increase in VAT introduced last month."

Additional reporting: Financial Times service

Dominic Coyle

Dominic Coyle

Dominic Coyle is Deputy Business Editor of The Irish Times