April 6 (Bloomberg) -- European Central Bank President Jean- Claude Trichet dashed investors' expectations for an increase in interest rates next month, sending the euro to its biggest decline in two weeks.

``The present high probability which is given for an increase of rates in our next meeting does not correspond to the present sentiment of the governing council,'' Trichet said at a press conference in Frankfurt after the ECB kept its benchmark rate at 2.5 percent. At same time, interest rates are still ``very low'' and inflation risks ``on the upside.''

Trichet caught investors off guard after a surge in German business confidence and manufacturing activity across the euro region prompted them to ramp up their expectations for a rate increase in May. With unemployment still weighing on consumer spending and oil prices above $60 per barrel, the ECB is giving the euro region's economy more time to gather strength.

``We need to see a more concrete confirmation of the recovery before they raise rates,'' said Michael Hume, chief European Economist at Lehman Brothers Holdings Inc. ``The best guess has to be for them to raise in June.''

The euro, which earlier climbed to a seven-month high of $1.2332, was worth $1.2211 at 5:55 p.m. in Frankfurt. The currency started dropping after Trichet declined to say the ECB needs to show ``vigilance'' against inflation, a word he has used to describe the ECB's stance at the press conferences preceding the March and December rate increases.

More Rate Increases

The yield on the German two-year bond, among the most sensitive to changes in rate expectations, fell 5 basis points to 3.24 percent by 3 p.m. after earlier rising to 3.34 percent. It touched 3.36 percent on April 3, the highest since October 2002.

Investors still expect the ECB to raise rates at least three times by the end of the year, according to futures prices. The yield on the three-month contract for December settlement was at 3.42 percent at 3:28 p.m. in Frankfurt, down from 3.49 percent this morning.

The contracts settle to the three-month euro-area inter-bank offered rate, which has averaged 15 basis points more than the ECB's benchmark rate since the currency's launch in 1999.

``We may be in danger of losing the bigger picture here,'' said Ken Wattret, senior economist at BNP Paribas SA in London. ``The data are consistent with a rate rise, whichever way you look at it.''

May and June

Banks including Barclays Capital, UBS AG and JPMorgan Chase & Co. revised their forecasts in the past month after economic reports pointed to faster euro-region growth and a deteriorating inflation outlook.

Manufacturing grew at the fastest pace in more than five years in March, German executives were the most optimistic since 1991 and inflation exceeded the ECB's ceiling for a 14th month.

After Trichet's comments, JPMorgan, Barclays and Morgan Stanley shifted their forecasts for a rate increase back to June.

Trichet said the ECB will have a ``wealth of new information'' on the economy in June, when it will hold its rate- setting meeting in Madrid, Spain.

He said it's wrong to assume the governing council ``do not increase rates when we are out of Frankfurt.'' The ECB holds two meetings a year away from its Frankfurt headquarters.

Trichet said growth risks have become more ``broadly balanced'' and pressure on consumer prices is still ``on the upside.''

`Heated Discussion'

``They are still minded to tighten monetary policy and make things less accommodative, but they really don't see a need at this stage to actually step up the hike in rates,'' said Howard Archer, an economist at Global Insight in London.

The contrast between Trichet's comment and remarks by some ECB council members in recent weeks may reflect a divide on the council between those arguing for higher rates and others who want to give growth more time to strengthen, said Holger Schmieding, co-head of European Economics at Bank of America in London.

``There could have been a heated discussion, with the doves preventing the acceleration in the pace of rate hikes the hawks may have wanted,'' Schmieding said.

Germany's Axel Weber said March 22 inflation was a ``cause for concern'' and Luxembourg's Yves Mersch said a week later the ECB would soon have to ``walk the talk'' to assert its inflation- fighting credentials. On the other hand, Lorenzo Bini Smaghi said on March 29 said investors would have to ``take responsibility for their own forecasts.''

More Time

``It is positive that they are giving the euro-zone economy time to gain and build up more of the strength we have been seeing for some time now,'' said Gernot Nerb, an economist at the Munich-based Ifo economic institute, which surveys 7,000 executives in Germany each month to gauge sentiment.

Euro-region retail sales fell in March the most in two years and the continent's jobless rate of 8.2 percent is still almost double the level in the U.S.

``The hawks would really have wanted to signal a hike,'' said Martin van Vliet, an economist at ING Bank NV in Amsterdam. ``But they would also like to be careful in normalizing rates.''

To contact the reporter on this story: John Fraher in Berlin at jfraher@bloomberg.net.

Last Updated: April 6, 2006 12:57 EDT