Stiff inflation and stagnating growth put the European Central Bank in the spotlight onThursday, as investors look past a widely expected interest rate hike to what might lie ahead.

The bank will almost certainly raise its benchmark rate to 4.25 percent, with ECB president Jean-Claude Trichet stressing its determination to counter eurozone inflation that hit a record 4.0 percent in June, economists said.

Of 51 financial institutions polled by Dow Jones Newswires, 50 expected the ECB to raise its main lending rate, though most expected the move would not be repeated this year.

Financial markets have priced in more than one increase however, with the three-month Euribor future contract implying a policy rate of just above 5.0 percent.

"The ECB looks set to raise its rates by 25-basis-points," said Bank of America economist Holger Schmieding.

"But will the ECB hike more than once? We do not expect Trichet to send a clear signal this time."

In June, he told a press conference the bank could raise its rate by "a small amount" on Thursday, more or less guaranteeing a rate hike.

"Nothing has happened in the last few weeks that could make the ECB want to incur the huge loss in credibility which a backtracking on the pre-announced rate increase would imply," Schmieding said.

But as economic indicators show the 15-nation economy slowing down sharply, persistent inflation, some see it reaching 4.2-4.3 percent in August or September, would put bank policymakers in an even tighter bind than at present.

On Tuesday, a purchasing manager's index showed that eurozone manufacturing activity contracted in June for the first time in three years.

"Clearly reeling"

"The euro area industrial sector, particularly in Spain and Italy, is clearly reeling from the combination of high commodity prices, a strong exchange rate and slowing demand growth," said UBS economist Sunil Kapadia.

The euro has risen to around 1.58 dollars owing in part to a widening difference between the ECB's main rate and the US Federal Reserve's Fed funds rate of 2.0 percent that helps underpin the US economy but also fuels oil price hikes.

Not only is oil priced in dollars, so prices rise as the dollar falls, but investors have ploughed into the commodity as a hedge against the US currency's falling value, pushing prices up further.

US President George W. Bush reiterated on Wednesday that his administration backed a "strong dollar," but such statements have lost credibility as the US currency continues to fall in value.

Meanwhile, eurozone political leaders worry that raising the zone's main lending rate will put the screws to economies that at best are weakening as in Germany and at worst are close to recession, as in Ireland and Portugal.

In the past week, French President Nicolas Sarkozy, Spanish Prime Minister Jose Luis Rodriguez Zapatero and German Finance Minister Peer Steinbrueck have urged the ECB to mull the effects of a rate hike would have on growth.

Trichet responded indirectly by telling the German daily Die Welt in remarks to appear Thursday the bank had to take decisive action to keep the situation under control, or run the risk "that inflation could explode."

Politicians want to restore consumer confidence with measures that spur economic growth, while Trichet maintains the best way to ensure growth is with a solid foundation built on what he calls "anchored" inflation expectations.

AFP