Eastern Europe Trade,Trichet Rate-Cut Resistance Empowered

March 3 (Bloomberg) -- Europe's expanding economy is helping buy Jean-Claude Trichet time to overcome the region's worst bout of inflation in a decade.

Signs are mounting that growth is holding up in the 15 nations that use the euro, fueled in part by demand for exports in eastern Europe and other emerging markets. That gives the European Central Bank's toughest inflation-fighters ammunition to block any push for lower interest rates.

Instead, pressure for higher borrowing costs may increase, with the European Commission forecasting inflation in 2008 at a nine-year high. ``The data is starting to favor the hawkish camp'' on the ECB council, says Elga Bartsch, an economist at Morgan Stanley in London.

Central banks around the world are split on how best to respond to the twin threats of a U.S. recession and a global inflation scare. While Ben S. Bernanke has slashed rates at the Federal Reserve, pushing the euro to a record against the dollar, policy makers in at least seven nations, including Sweden and Australia, have raised borrowing costs. ECB President Trichet and council members including Germany's Axel Weber have said the demand in markets such as eastern Europe and Asia is helping to compensate for the effect of the U.S. slowdown.

``Emerging markets are motoring on, and growth could well reaccelerate'' in the euro region, Bartsch says.

Staying Power

Among recent signs of the region's staying power, business confidence in Germany, Europe's largest economy, rose more than economists forecast in February and unemployment dropped to the lowest level since 1992. Meanwhile, growth in Europe's services industries accelerated.

``People still underestimate the strength and resilience'' of the European economy, says Kenneth Broux, an economist at Lloyds TSB Group PLC in London.

Those are all welcome developments for Trichet as his inflation concerns mount. Weber said last week investors are ``clearly'' underestimating the scale of the threat. The European Commission says prices will rise 2.6 percent in 2008, the most since the euro was introduced in 1999. The ECB tries to keep inflation below 2 percent.

To be sure, pressure for rate cuts hasn't evaporated because growth in some euro nations is faltering. Morgan Stanley says Italy may slip into a recession this year. Deutsche Bank AG forecasts that Spanish house prices, an engine of growth during the past decade, may drop 8 percent in 2008, the first decline on record.

Bets on Lower Rates

Investors, who reduced their expectations of ECB rate cuts early last month, have since replaced those bets as the euro's 15 percent appreciation against the dollar over the past year threatens to stall growth. The implied rate on the Euribor interest-rate futures contract maturing in December dropped 8 basis points, or 0.08 percentage point, on Feb. 29 after the euro rose to a record $1.5239.

Trichet himself stoked expectations of rate cuts just a month ago, when he spoke of ``unusually high uncertainty'' about growth. Now, as signs of price pressures multiply, he's been forced to tamp down investors' speculation that the ECB will soon cut rates.

German steel workers won a 5.2 percent wage increase this year, and Grandi Molini Italiani SpA, Italy's largest wheat miller, said last week it has tripled flour prices since July.

Sarkozy Worried

Even French President Nicolas Sarkozy, one of Trichet's strongest critics, said Feb. 21 that accelerating inflation in France ``worries me.'' Inflation in the euro region climbed in January to a year-over-year rate of 3.2 percent, the fastest in 14 years.

Trichet has stressed that the bank is in a neutral stance, unwilling to commit on policy until the economic outlook clears. The ECB, which all 54 economists surveyed by Bloomberg News say will keep its benchmark rate at 4 percent on March 6, will publish revised growth and inflation forecasts this week.

``Inflation will not slow as markedly as supposed,'' Weber said Feb. 27. Juergen Stark, who's in charge of the ECB's economics division, said last week he's ``highly dissatisfied'' with the current pace of price increases.

Buttressing the case of those who say this is no time for interest-rate cuts, the euro region's economy is getting a lift from the European Union's expansion since 2004 to include 12 mostly former Communist nations.

`Awash With Money'

Demand from eastern Europe ``buys the ECB time,'' says Andrew Bosomworth, a fund manager at Pacific Investment Management Co. in Munich. ``Growth is incredibly dynamic. The place is awash with money and booming.''

Sales to new member countries have more than doubled since 2000. Exports to Russia, which now sits on the European Union's eastern border, have almost tripled. By contrast, exports to the U.S. have expanded just 12 percent in the same period. The euro region now exports more to new EU members than to the U.S.

Sales to Poland and Russia jumped 22 percent in November from a year earlier, and exports to the Czech Republic rose 18 percent. By contrast, sales to the U.S. fell 1 percent.

The region's export boom is also cheering executives trying to shield their businesses from the U.S. slowdown.

Vienna-based Wienerberger AG, the world's biggest brickmaker, said Feb. 14 that growth in eastern Europe will help it cope with ``further weakness'' in the U.S. Deutsche Bank AG Chief Executive Officer Josef Ackermann said Feb. 7 that the bank's wealth-management businesses in eastern Europe and Asia are growing as much as 30 percent a year.

Euro's Rally

Trade with eastern Europe is also helping the euro region's exporters cope with the currency's rally against the dollar in the past year. All of the EU's newcomers have pledged to switch to the euro at some stage, meaning their currencies move in closer tandem with the euro than the dollar.

Some of their central banks are already raising rates. Trichet said Feb. 14 that policy makers around the world are ``doing what is necessary, each of us in our own environments, which are very different.''

Besides the central banks of Sweden and Australia, policy makers in Russia, the Czech Republic, Poland, Romania and Serbia have all increased borrowing costs this year. The Fed has slashed its benchmark rate five times since September. The Bank of Canada cut interest rates in January, and the Bank of England cut its key rate in February.

Weber argues that traders would be wrong to expect the ECB to follow the Fed and the Bank of England. Since the ECB's last forecasts Dec. 6, which projected inflation of around 2.5 percent this year, oil and wheat prices have touched records.

Investors expect euro-region inflation to average 2.24 percent annually during the next decade, yields on European bonds show. That's close to the highest rate since 2005.

``The ECB is facing genuine inflation risks and, unlike the Fed, it won't choose to ignore this threat,'' says Dario Perkins, senior European economist at ABN Amro Holding NV in London.

To contact the reporters on this story: John Fraher in London at Gabi Thesing in Frankfurt at .

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