ECB kicks it up a notch

When the Governing Council of the European Central Bank (ECB) meets this Thursday in Frankfurt, it is likely to bump up euro-area interest rates by 25 basis points.

This will come as no surprise to markets; the Bank has hinted for some time that a rate increase is likely following reports of rising euro-area inflation, which reached 3.7% in May. This reflects the rising costs of food and energy, which, if excluded, puts inflation at roughly 2.0%. Since food and energy inflation are driven by global factors, it is doubtful the ECB's move will have much effect.

New economic data also shows a general slowdown in economic activity across the euro-area: the closely-watched June Ifo Business Climate Index for industry and trade in Germany has fallen, and euro-area purchasing manager data have ebbed to their lowest levels since May 2005. For some euro-area economies, such as Spain and Ireland, the decline of home values has added to the souring economic mood -- a rate hike will hurt them most. Yet considering the economic downturn in the euro-area is likely to be less severe than in the United States and the United Kingdom, the ECB can still signal it is still serious about rising inflation without hurting the overall euro-zone economy.

Rising euro-area rates also worsen the prospects of the weak dollar. Many consider the falling dollar to be a major factor in record-high commodity prices. By this logic, the ECB's move may perpetuate a negative trend.