Europe's economy is accelerating out of its recent trough, according to new forecasts from Brussels, but stubborn inflation and high government borrowing could hasten an early interest rate rise in the eurozone.

Resurgent domestic demand should help to drive growth in the European Union from 1.5 per cent this year to 2.1 per cent in 2006 and 2.4 per cent in 2007, the European Commission said.

The return of healthy growth comes at a crucial time for Europe, where high unemployment, consumer pessimism and protectionism are widespread.

However, economists said that the Commission's upbeat autumn forecast increased the likelihood that the European Central Bank would act soon to rein back inflation, raising rates for the first time in five years to 2.25 per cent.

Joaquin Almunia, EU monetary affairs commissioner, expects eurozone inflation to stay above the ECB's 2 per cent target for both 2006 and 2007, upping previous forecasts to 2.3 per cent and 2.2 per cent respectively.

The bank could also be swayed by Mr Almunia's warning that the eurozone's biggest economies France, Germany and Italy will continue to break the EU's borrowing limits for the next two years. “It's been clear for a long time that the ECB wants to raise rates and now the time seems to have come,” said Christoph Weil, a senior economist at Commerzbank AG in Frankfurt.

But Mr Almunia's message was overwhelmingly positive, buoyed by strong growth figures in the third quarter of 2005.

“After a disappointing first half, the euro area and the EU are in a good position to take advantage of a global outlook that remains bright,” he said.

He predicted that the EU would create six million jobs within the next three years, bringing the jobless rate down from 9.0 per cent at the end of 2004 to 8.1 per cent in 2007. The European economy faltered earlier this year with the oil price rise, but Mr Almunia said that business confidence and investment were returning. He hoped corporate confidence would infect Europe's notoriously cautious consumers, particularly in Germany, Europe's biggest economy.

But even a return to solid growth over the next two years may not ease the dire state of Europe's public finances, with average EU government deficits stuck at about 2.8 per cent just below the stability and growth pact's 3 per cent limit.

Mr Almunia said he “proposed to continue” early next year action under the pact against Germany, whose deficit is forecast to hit 3.7 per cent next year.

However, Mr Almunia hoped to persuade the French government to take extra measures to nudge its deficit below 3 per cent in 2005 and 2006, ending the long-running fiscal stand-off between Paris and Brussels. Standard & Poor's, the ratings agency, said yesterday that France's deteriorating public finances and ageing population meant its debt now compared “unfavourably” with all other AAA-rated countries apart from Germany.

Other countries continue to cause concern to Mr Almunia and the ECB, particularly Italy and Greece which combine high deficits with debt to GDP ratios of over 100 per cent and Hungary. Britain's deficit is also predicted to stay at or above3 per cent until 2007.

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