European Central Bank to Raise Interest Rates

By NICHOLAS WINNING from Dow Jones for WSJ

LONDON—Euro-zone private sector output is growing at the strongest rate for more than four-and-a-half years, but surging inflation suggests the European Central Bank may raise interest rates sooner than expected, the preliminary results of a survey by financial information firm Markit showed Monday.

The euro-zone economy could grow 0.7% in the first quarter, up sharply from the disappointing 0.3% expansion seen in the final three months of 2010 when activity was hit by severe winter weather, according to Chris Williamson, chief economist at Markit.

There are also signs that divergences between strong growth in Germany, Europe's biggest economy, and the smaller states at the heart of the currency area's debt crisis may be starting to narrow, he said.

"Less welcome are the signs of inflationary pressures building up. The jump in rates charged for goods and services was the largest ever recorded by the survey, highlighting the speed with which prices are being driven higher by rising food, oil and other commodity prices," Mr. Williamson said.

The flash reading of the euro zone's Composite Output Index, a gauge of activity based on partial results of a survey of manufacturing and services firms, rose to 58.4 in February from 57 in January, the highest reading since July 2006. A reading above the neutral 50 level indicates an expansion in activity.

The manufacturing Purchasing Managers' Index rose to 59.0 from 57.3 in January, the highest reading since June 2000, while the Services Business Activity Index rose to 57.2 in February from 55.9 the previous month, marking the strongest reading since August 2007.

Economists said the results of the survey increased the risk that the ECB could start tightening monetary policy earlier than expected. The central bank, which aims to keep inflation just below 2% over the medium term, has held rates at a record low of 1% since May 2009.

"Our forecast is for the first rise in rates to materialize in the fourth quarter this year, with various factors holding the ECB back, including a potential logjam in political discussions over bolstering the support mechanisms for countries in difficulty, and weak money and bank lending growth," said Ken Wattret, chief euro-zone market economist at BNP Paribas.

Growth in new orders gathered pace for the fourth month running and at the sharpest rate since June 2007. Manufacturing new orders grew at a rate equal to last March's 10-year high, with exports showing the largest monthly increase since April 2000. Services new business posted the strongest monthly gain since August 2007.

Employment rose for the 10th consecutive month in February as backlogs of work posted the largest monthly increase since July 2006, but job creation remained well below the pre-crisis peak, Markit said. Manufacturers took on staff at the fastest pace since June 2000, but a far more modest increase was registered in the services sector.

"Today's better-than-expected PMI data indicate that the euro-zone recovery is still in full swing, and remains little affected by the lingering sovereign debt problems in the region," said Martin van Vliet, an economist at ING. "This, coupled with signs of inflationary pressures building, reinforces expectations of a first ECB rate hike in the second half of this year."

WSJ Article