April 23 (Bloomberg) -- European Central Bank officials are raising the prospect of interest-rate increases for the first time since the global credit squeeze began last August, stepping up their battle to keep inflation in check.

Comments by policy makers including Axel Weber and Christian Noyer are forcing investors and economists into an about-face after they previously bet the bank would follow the U.S. Federal Reserve in cutting rates to shore up growth.

The ECB officials are reacting to a surge in oil and food prices, which pushed inflation to a 16-year high of 3.6 percent in March. They're concerned that faster inflation will feed into wage demands and prompt companies to pass on higher costs. The contrasting stances by the world's two most important central banks helped push the euro to a record $1.60 yesterday.

``They're not threatening an immediate rate hike, but the hawks are framing the debate now,'' said Nick Kounis, an economist at Fortis Bank NV in Amsterdam who expects the ECB's next step to be an increase in mid-2009. The stronger rhetoric ``has been forced on them by the fact that headline inflation has surprised significantly.''

The ECB last month forecast that inflation would average about 2.9 percent this year and 2.1 percent in 2009. The bank aims to keep the rate of consumer-price increases just below 2 percent. The UBS Bloomberg Constant Maturity Commodity Index, which tracks 26 raw materials, has risen 37 percent in the past year, with commodities including oil, corn and rice hitting records.

High Enough?

The Frankfurt-based ECB on April 10 kept its key rate at a six-year high of 4 percent, and President Jean-Claude Trichet said current policy will help the bank achieve price stability. Since then, policy makers including Weber have said they're not sure rates are high enough to contain inflation.

The ECB will ``monitor very closely all developments in the coming weeks and decide whether the current level of interest rates ensures we'll meet our objective'' of controlling inflation, Weber, who heads Germany's Bundesbank, said this week.

``If needed we'll move rates,'' France's Noyer told RTL radio yesterday. By contrast, on April 4, he said he was ``absolutely certain'' inflation would drop below 2 percent at the end of 2008.

Noyer's colleague Yves Mersch of Luxembourg said the ECB will have to raise the question ``every month'' whether an increase in interest rates is necessary, the Financial Times Deutschland reported yesterday, citing an interview.

`Wishful Thinking'

Eonia swap contracts, a widely used market gauge of interest- rate expectations, rose to 4.1 percent yesterday, up from around 3.2 percent in mid-March.

``The market is starting to quickly re-price its rate expectations as it realizes it was wishful thinking to have thought the ECB would follow the Fed in cutting,'' said Guillaume Menuet, an economist at Merrill Lynch & Co. in London, who predicts the ECB will leave its key rate unchanged through 2009.

The Fed has lowered its benchmark rate by 3 percentage points since mid-September, taking it to 2.25 percent, as the U.S. economy teetered on the brink of a recession. The Bank of England on April 10 pared its key rate for the third time, to 5 percent. The Bank of Canada yesterday lowered its benchmark rate by half a point to 3 percent.

Financial institutions worldwide have reported losses or writedowns of $290 billion since the start of 2007. The cost of borrowing euros for three months has surged the most in four months, with the Euribor rate increasing to 4.82 percent yesterday compared with 4.37 percent on Feb. 22, the European Banking Federation said.

IMF Pessimism

Growth in Europe's manufacturing activity slowed more than forecast in April, while a gauge of growth in services industries such as banking and telecommunications unexpectedly rose.

The International Monetary Fund estimates growth in the 15- nation euro region will slow to 1.4 percent this year from 2.6 percent in 2007. Inflation is forecast to drop to 1.9 percent.

As soon as commodity prices start to drop, the ECB needs to lower rates, ``not into 2009, but in the next three, six months.'' IMF Europe Director Michael Deppler said in a Bloomberg Television interview this week.

``Inflation expectations may recede rapidly'' if the IMF is right, Noyer told the Wall Street Journal in an interview late yesterday. Interest-rate moves ``can go both ways.''

For now, inflation expectations, as measured by French inflation-indexed bonds, are rising, going above 2.3 percent this week from 2.1 percent a month ago, and fueling the ECB's concerns about so-called second-round effects.

Germany's Ver.di union last month negotiated a settlement for as many as 2.1 million public-sector staff that it said was worth 8.9 percent over two years. The German chemical-workers' union last week settled a new contract that raises wages 4.4 percent this year and another 3.3 percent in 2009.

``It would be very challenging for the ECB to lower interest rates, particularly in the months ahead,'' said Julian Callow, chief European economist at Barclays Capital in London. ``As for rate increases, they can't be ruled out.''

To contact the reporter on this story: Christian Vits in Frankfurt cvits@bloomberg.net; Simon Kennedy in Paris at skennedy4@bloomberg.net

Last Updated: April 23, 2008 05:45 EDT