---- by Steve Whitehouse ----
PARIS (AFX) - Euro zone inflation remains on a downward trend, with the unexpectedly high preliminary data for January from Germany and Italy reflecting the impact of the introduction of euro notes and coins as well as seasonal variations, economists said. The data prompted a number of economists to raise their forecast for January euro zone inflation - which Eurostat publishes tomorrow - to 2.5-2.6 pct, but left the market divided over the longer-term implications for interest rates. Earlier, the German Federal Statistics Office said German consumer prices rose 0.9 pct month-on-month and 2.1 pct year-on-year in January, on the basis of figures from six federal states. Figures from Italian cities were already calculated to point to an Italian January inflation rate of 2.4-2.5 pct. The German figures were above market expectations and prompted some economists to revise up their forecasts for euro zone inflation. Before the German data economists were forecasting a euro zone inflation figure of around 2.4 pct. "The German number was certainly quite disappointing...so, given Italy, I would guess 2.6 pct for the euro zone," said Robert Prior of HSBC. Klaus Baader said he is forecasting a January figure of 2.5 pct. Although the German figure was particularly strong, it will be partly offset by downward seasonal effects in Greece, Belgium and Ireland, leading to a month-on-month rise of 0.3 pct, one third of the German increase, he said. Tax rises and seasonal food price increases played a key part in the German inflation figures, and some economists also detected some impact from the switch to euro notes and coins, despite the German statistics office's insistence that it had no significant impact. "Euro zone consumers are paying for the introduction of euro notes and coins. After the Italian inflation data, German state CPI numbers confirm a hefty rise in inflation in January," Rabobank economists said. "The shift to euro prices does appear to have pushed up prices in certain sectors, in particular in clothing and a number of services, particularly hotels and catering," said Baader. The upturn in euro zone inflation in January will not alter the fact that inflation is on a downward trend overall, with the European Central Bank expecting it to come back below its 2 pct price stability ceiling in the first half. "This is a blip on a downward trend," said Prior. Inflation fell to 2.1 pct in December from a peak of 3.4 pct in May and is expected to resume its downward course in February. Base effects are expected to lead to a significant drop in inflation in April and May, and the headline rate will probably drop back below 2 pct in April, said Prior. Bear Stearns said the headline rate could even drop to less than 1 pct in May and June. But Baader said that while headline inflation is coming down, core inflation is rising, with all of the projected fall in headline inflation coming from food and energy prices. The ECB governing council is expected to leave interest rates unchanged when it meets in Maastricht next week, and the January inflation data will not sway its decision either way, economists said. But they disagreed about the longer-term implications of the inflation trend for ECB rates. Baader said the January data strengthens his view that ECB easing is at an end, and that the ECB will hike rates sharply in the second half. "A figure of 2.5 pct would be the highest rate of increase since September and would therefore undo quite a bit of the good work that's been done on disinflating the euro area economy," he said. The upward trend in core inflation will be of particular concern to the central bank, he said. Rabobank economists agreed. "The ECB will not cut rates any more as the return of growth will make any further rate cuts unnecessary and the break below 2 pct in inflation will come too late," they said. But Prior said HSBC still expects 75 basis points of rate cuts by the middle of the year, starting with a 25 basis point easing move in April. "I would expect a combination of downside inflation surprises and downside surprises on growth for the end of last year to trigger a further reduction in rates in the spring," he said.