---- by STEVE WHITEHOUSE ----
PARIS (AFX) - The European Central Bank will leave interest rates unchanged at Thursday's governing council meeting following a sharp acceleration in euro zone inflation in May, economists said. The council meeting is being held in Dublin, which might be seen as an inappropriate venue for an easing move in view of Ireland's high inflation rate, they said.
Euro zone inflation rose to 3.4 pct in May from 2.9 pct in April, with Ireland recording an inflation rate of 4.1 pct.
In a poll of 37 economists by AFX News and Agence France-Presse last week, 32 said they expect the minimum bid rate on the ECB's main refinancing operations to be left unchanged at 4.50 pct at Thursday's meeting. Four forecast a cut to 4.25 pct, while one predicted an easing move either this week or at the July 5 meeting in Frankfurt.
However, most economists -- 25 of the 37 -- expect rates to be cut in July or August as concerns over the current high inflation rate give way to worries about growth.
"We think that despite the high inflation data, the weak activity data will push them into another cut," said Gwyn Hacche of HSBC. There is little in the ECB council members' words that suggests that an interest rate cut is likely this week, with ECB president Wim Duisenberg continuing to describe rates as "appropriate" at the last council meeting on June 7.
The ECB was criticised for not preparing markets for its May 10 rate cut, so this time it may want to send a clear signal before it moves, economists said.
"Following the strong criticism of the last surprising move, the ECB might this time want to prepare markets sufficiently. Hence, a move at the upcoming meeting might be too soon for a rate cut. But President Duisenberg might further soften up his wording at the meeting in Dublin, preparing the market for a cut as early as early July," said Eckhard Schulte and Rainer Guntermann of Dresdner Kleinwort Wasserstein.
However, Klaus Baader of Lehman Brothers said the lesson of the May 10 cut is that little store can be set by ECB statements. "The ECB is now very well practised in saying one thing and doing something completely incompatible," said Baader, who said he wouldn't completely rule out a rate cut this week, although he sees the chances as less than 50 pct.
But Peter Saacke of Merrill Lynch said the ECB cannot give warning of a rate move, because it doesn't know ahead of a meeting what the balance of opinion on the 18-member council will be.
"What we are dealing with here is a governing council which is split and where they don't know beforehand whether a consensus for another rate cut will be forged at the next meeting or not. So if they don't know that, they can't warn," he said.
And although the current headline inflation rate is uncomfortable for the ECB, which aims to keep inflation below 2 pct in the medium term, it will not necessarily prevent an interest rate cut. This is because the ECB regards its monetary policy as being directed at containing risks of future inflation, rather than at the current headline rate.
"The inflation pressures seen in May must not dissuade the ECB from further monetary easing. These pressures are the result of exceptional factors -- a sharp rise in food and energy prices. These are pressures on which interest rates can have no impact," said Marc Touati of Natexis Banques Populaires.
In any case, inflation is expected to start to decline again in June, and the ECB will have the first evidence of this in the form of data for German states and Italian cities when it holds its first meeting in July, economists said.
The ECB has expressed confidence that inflation will decelerate over the course of the year, although it still expects annual average inflation to be well above the 2 pct price stability ceiling. Its own in-house staff projections point to an average 2001 inflation rate of 2.3-2.7 pct, and some economists say even these figures may be too optimistic.
In its June monthly bulletin the ECB cautioned that the fall in inflation could be delayed by the recent recovery in oil prices and the weakness of the euro.
However, slowing growth and its impact on future inflation pressures now appear to be of greater concern to the ECB than this year's inflation rate.
It revised down its projection for 2001 growth to 2.2-2.8 pct from 2.6-3.6 pct, and at the same time said that a sharper than expected global slowdown cannot be ruled out, with negative consequences for euro zone growth.
Schulte and Guntermann described the growth projections as "overly optimist".
"The risk associated with the release of (the) forecast therefore again seems to be that the governing council will not distance itself early enough from the projections. The ECB would then again be stigmatising itself as lagging behind the reality," they said. However, they said it is significant that the ECB is now talking about downside risks to growth for the first time.
Economists said there will be further evidence of the extent of the euro zone slowdown in economic data released in early July, particularly sentiment surveys, and this will prompt a further ECB easing move.
"Real economic data is so weak that the ECB has little choice but to continue easing," said Saacke.
There is also likely to be some pressure on the ECB to ease rates in July from politicians and from other G7 countries, even though overt pressure has often proved counterproductive in the past. German Finance Minister Hans Eichel last week called for the ECB to help boost growth, although he acknowledged that current inflation levels restrict its room for manoeuvre.
The possibility of a further U.S. rate cut at the June 26-27 FOMC meeting could put pressure on the ECB to ease, particularly if the move gives the dollar a further boost.
And the non-euro zone G7 countries could look to the ECB to play a greater role in supporting global growth at international meetings in July, economists said. G7 finance ministers and central bankers meet in Rome on July 7 and G8 leaders hold their annual summit in Genoa from July 20 to 22.
Schulte and Guntermann said they expect the ECB to cut rates ahead of the Genoa summit.
The outcome of the July 3 OPEC meeting could also play a role in the ECB's deliberations, because of its probable impact on oil prices and hence on inflation.
"The ECB seems to expect with some interest the OPEC meeting on July 3. So we do not expect a rate cute before that meeting," said Sirpa Wallius of Nordea.
Meanwhile, monetary developments will also be used to justify a further easing move, economists said.
Evidence on the scale of upward distortions in the M3 growth data was one of the main reasons given for the May 10 rate cut decision. Details on the second of these two distortions are not yet available, but when they are published, a revised M3 series will probably show M3 growth running well below the ECB's 4.5 pct reference value. Duisenberg said the distortions were taken into account in the May 10 decision, indicating that the ECB will therefore not automatically cut rates when it gets details on the second distortion.
However, a further period of M3 growth below the reference value could well be used to underpin a further rate cut, economists said. And the ECB also recently changed its tone on bank lending, which marks a further downward revision in its assessment of inflation risks, economists said.
In the June monthly bulletin the ECB said strong growth in loans to the private sector no longer represents a risk to price stability, arguing that much of the increase is the result of special factors which will not boost consumer spending and inflation.