IF NOT now, then when? Alan Greenspan’s done it, Mervyn King can’t stop doing it, and there is building speculation that Jean-Claude Trichet, President of the European Central Bank (ECB), is also set to join the crowd and begin raising interest rates. The ECB may have left rates on hold after its meeting last week, but markets believe that the enigmatic M Trichet will soon begin to push eurozone borrowing costs higher.

On the face of it, there looks like a reasonable case for higher interest rates in the eurozone. Growth in the first quarter came in at a respectable annualised rate of 2.3 per cent and surveys point to a further strengthening in coming months. Inflation is above the central bank’s 2 per cent target and is likely to stay there in the short to medium term. The ECB has also emphasised that inflation expectations are creeping higher — a warning sign for any central banker.

But, dig a little deeper, and the case for higher rates in the eurozone is far less compelling than in the US or Britain. Indeed, there are sound economic reasons for a prolonged period of unchanged rates on the Continent. Not least of these is the composition of growth in the eurozone, which is fundamentally different from America or the UK.

Both here and across the Atlantic, consumers have been on a borrowing binge. Rates were kept deliberately low over the last two or three years to help insulate the domestic economy from a series of shocks, including the dot-com crash, September 11 and the Enron and WorldCom accounting scandals. With the world economy now on the mend, both the US Fed and the Bank of England are now focusing on bringing consumer debt under control. But the problems facing the ECB are very different.

In the eurozone, the problem is one of excessive consumer prudence, not one of profligacy. While UK and US consumers have been splashing out regardless, their counterparts on the Continent have been anxiously saving the pennies. In the eurozone as a whole, quarter-on-quarter real consumer spending growth averaged a little more than 0.1 per cent last year. This compares with just over 0.5 per cent in the UK and almost 1 per cent in the US.

It is true that there was a pick-up in eurozone consumer spending in the first quarter of 2004. After adjusting for inflation and seasonal variations, eurozone consumption increased by 0.6 per cent in the first three months of the year. But one reasonable quarter of consumer spending growth is no guarantee of a self-sustaining economic recovery. In any case, this headline figure disguises the fact that some eurozone countries are really struggling to kickstart activity in the household sector.

Germany is a case in point. German consumer spending has not grown in any quarter since the first three months of 2003, according to European Commission data. The 1.7 per cent drop in German retail sales during May suggests a further contraction of consumer spending could be on the cards when second quarter figures are unveiled later this summer. It is not only German consumers that are feeling unhappy about life — Holland is another economy where consumer spending has shrunk in recent months.

With consumers still refusing to spend in Europe’s biggest economy and household spending fragile in other parts of the eurozone, it is hard to be bullish about prospects on the Continent. And to the extent that there has been a tentative revival in growth in the eurozone as a whole, an early rise in interest rates could easily trigger a relapse.

The primary goal of the ECB is to achieve price stability. So if inflation was set to run out of control the ECB would have little choice but to put up rates — irrespective of the growth picture. But although inflation is above the ECB’s 2 per cent target, and is likely to remain there at least for the next few months, much of the recent rise in prices has been due to short-term factors such as oil. Most analysts expect eurozone price pressures to ease next year, with the latest consensus forecasts pointing to an inflation rate of 1.7 per cent in 2005.

So what of the supposed upward shift in inflation expectations spoken of by ECB officials? Well, it all depends on where you look. As the economics team at Merrill Lynch points out, financial market inflation expectations — as defined as the gap between nominal bond yields and index-linked yields — have risen sharply in recent months. But other measures of inflation expectations remain benign.

For example, the regular surveys of consumer inflation expectations conducted by the European Commission suggest there is no need for panic. So far, wage settlements in the eurozone have also been restrained. Of course, there is no room for complacency. If, say, recent rises in the oil prices end up feeding through into retail prices and then into wages, the ECB would need to act. But at present there is no need to pull the rate trigger.

Not all the blame for the eurozone’s lacklustre growth can be laid at the ECB’s door. Structural problems — for example, in the labour market — continue to hamper growth on the Continent. If the ECB waits until the eurozone achieves levels of growth similar to those seen in the US, or Britain, then inflation will have risen too far.

Unless and until the eurozone embraces structural reform, the continental economy will continue to perform below potential. But the ECB still has a role to play in stimulating growth. With the recovery so fragile, and with no compelling evidence that inflation is shooting higher, M Trichet should hold steady on interest rates. Tempting as it may be to follow the lead of the Bank of England and the US Fed, the ECB needs to steer its own course.

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