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UPDATE 3-Bullish German investors see earlier ECB hike

* Forward-looking ZEW sentiment index highest since July

* ZEW sentiment 15.4 vs 4.3 in Dec and Rtrs poll of 6.8

* Widening economic gulf in euro zone a headache for ECB

* ZEW: 50 pct of investors see ECB rate hike within 6 months

* Rate hike would be appropriate for Germany -HWWI institute

(Adds ZEW and Berenberg economists, euro reaction)

By Sakari Suoninen and Josie Cox

MANNHEIM, Germany, Jan 18 (Reuters) - German investors are increasingly optimistic about the economy and half expect higher interest rates by July, a survey showed, highlighting the two-speed euro zone recovery and the dilemma it creates for the ECB.

The Mannheim-based ZEW think tank said sentiment surged in January, reflecting growing confidence that Germany’s traditionally export-focused industrial sector will create new jobs and investments this year to spur further robust growth while also boosting demand at home.

Published less than a week after comments on inflation from European Central Bank President Jean-Claude Trichet prompted talk of possible rate hikes, the survey found about 50 percent of investors expect an ECB tightening within six months, a few months earlier than markets are currently pricing in. [ECB/INT]

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For a graphic showing German ZEW economic sentiment:

r.reuters.com/nak86r

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Foreign exchange markets seized on the data, bidding up the euro and selling the dollar although the single currency later gave up some of its gains to trade back around the $1.34 mark.

Thomas Straubhaar, head of Hamburg-based HWWI economic research institute, told Reuters the ECB should not wait too long before raising its main lending rate.

“An interest rate hike would be right for Germany to prevent the inflation genie from getting out of the bottle,” he said.

But ZEW economist Michael Schroeder told reporters on Tuesday that widening divergences would place ECB policymakers in a tight spot as rates are too low for Germany and too high for ailing euro zone states like Greece and Ireland.

ECB rate-setter Athanasios Orphanides said on Monday Trichet’s policy statement had not been “overly hawkish” and that markets sometimes over-reacted to the bank’s underlying message. [ID:nLDE70G0VB]

INFLATION

“We have a strong divide in macroeconomic developments and I don’t know how the ECB can make it right for everyone,” Schroeder said, adding that most investors expect a pick-up in inflation over the coming six months.

Inflation concerns took centre stage on Tuesday in Britain, where consumer prices surged by a greater than expected 3.7 percent in December, piling pressure on the Bank of England to raise interest rates despite slow growth and looming austerity measures. [ID:nLDE70H0W0]

The ZEW's monthly index jumped to 15.4 points from a reading of 4.3 in December, its highest level since last July and easily surpassing the consensus forecast of 6.8 points in a Reuters poll of 36 economists.ECON

“The German economy is cruising along safely. It looks as if there is almost blind trust in the strength of the German recovery,” said ING Financial Markets economist Carsten Brzeski.

In contrast to the ZEW survey, a Reuters poll on Monday showed that although economists feel the chances of an earlier rate move have increased, most still expect the ECB to hold them until late this year. [ID:nSLAHCE7N2]

While January’s ZEW is impressive relative to expectations, Berenberg Bank Chief Economist Holger Schmieding said it should be seen in the context of last April’s peak of 53.0 that was followed by a six-month plunge to minus 7.2 in October.

“Investors are finally beginning to get beyond their exaggerated concerns over a dent to exports from euro zone fiscal tightening and a potential U.S. double dip,” he said.

POINTER TO IFO?

The ZEW precedes Friday’s Ifo index, which is considered to be the most reliable sentiment gauge when predicting changes in domestic output.

Germany has been among the most resilient of Western industrialised economies in the past year thanks to a strong export sector that supplies dynamic emerging markets with the goods needed to improve infrastructure and boost productivity.

Europe’s largest economy expanded at the fastest pace since reunification in 2010 and forecasters like M.M. Warburg Chief Economist Carsten Klude believe it could grow at more than 3 percent for the second straight year. [ID:nLDE70A1OB]

Years of wage restraint paired with a weak euro has ushered in what some experts believe will be a decade of above-average growth for Germany, once overall household consumption starts to improve on the back of record high employment levels.

The country’s relative prosperity, however, has triggered tensions among other countries using the euro that feel Germany has unfairly kept a lid on wages at the cost of internal demand that could spur greater imports and growth elsewhere.

On Monday, euro zone finance ministers met in Brussels to discuss whether to beef up the euro area’s rescue fund as Athens distanced itself from one cabinet minister who called for a de facto restructuring of its debt obligations. [ID:nL3E7CI0C4]

The ZEW’s monthly index was based on a survey of 284 analysts and investors and conducted between Jan. 3 and Jan. 17.

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