European inflation has picked up to 1.7 per cent on the back of rising oil prices and the continuing recovery in the euro zone area, raising the prospect of quicker than expected interest rate increases.

Inflation - which is at its highest rate in 28 months - ranged from 3.9 per cent in Ireland in December to 1.4 per cent in Germany and France. Initial indications are that German inflation will pick up sharply in January. According to Dr Dan McLaughlin, chief economist at ABN Amro, there is now a definite risk, as German consumer prices rise - and for technical reasons - that euro zone inflation for January will be 2.1 per cent, just above the European Central Bank's reference value of price stability.

At the same time, the ECB's other main target, money supply, is also likely to be on the rise for a couple of months, again mostly due to technical reasons.

The result is that the pressure on the ECB to raise interest rates will be considerably increased over the coming months.

The debate is now whether the ECB is likely to raise rates at its meeting on February 2nd or to wait until March before moving.

According to Dr McLaughlin, the main reason that the February move looks unlikely is that the Bundesbank president, Mr Ernest Welteke, has not yet hinted at any rise.

Last autumn the ECB president, Mr Wim Duisenberg, first hinted at a rise in October but this was not echoed by the Germans until very close to the beginning of November, when the rise was to take place.

As a result, Dr McLaughlin added, a rate rise does not look likely at the moment in February but it is Mr Welteke who should be watched for a sign that he is beginning to prepare the ground.

Dr McLaughlin also noted that if oil prices are taken out of the inflation data, prices would have risen by only 0.9 per cent in December. A corresponding stabilisation or decline in oil prices could see the inflation numbers fall back. Money growth is also likely to fall back, as the build-up of overnight bank deposits as a result of the creation of the euro and Y2K begins to retreat. As a result, the inflation outlook could be fundamentally altered by March or certainly April.

However, according to Mr Jim Power, chief economist at Bank of Ireland, the ECB may raise rates next month by as much as half a percentage point rather than the more usual quarterpoint rise.

The bank will want any rate move to have an impact on the value of the currency, which fell below parity with the dollar for a short time again last night.

However, Mr Power said the ECB should wait until March to see one month's further economic data and allow the recovery to take root.