IMF ups eurozone GDP forecast, now backs ECB rate hikes

SINGAPORE, Sep 14 (Reuters) After a year of urging the European Central bank in vain to hold off on interest rate rises, the IMF on Thursday said the central bank should probably tighten policy further to keep inflation under wraps as growth rebounds.

The International Monetary Fund, in its twice-yearly World Economic Outlook, raised its growth forecast for the euro zone in 2006 by nearly half of a percentage point to 2.4 percent and predicted 2.0 percent growth in 2007.

That followed a meagre 1.3 percent rise in gross domestic product in 2005.

Foremost of its recommendations was a hindsight endorsement of rate hikes by the European Central Bank (ECB), and an acknowledgement that it may need to further tighten the noose on credit, though it urged the ECB to do so cautiously.

''Looking forward, further interest rate increases will likely be needed to maintain price stability over the medium term if the expansion develops as expected,'' said the report.

The IMF said underlying inflation remained within acceptable bounds and labour costs were subdued.

So the ECB should play the rate rise game carefully, the IMF said, partly because of the risk of pushing the euro's foreign exchange rate upwards, which can dent exports and stunt growth.

While U.S. labour costs are surging and causing concern about inflation there, the cost of labour in Europe has actually fallen for most of the past decade once inflation and gains in productivity are taken into account.

The ECB started increasing interest rates in December, when they stood at a historic low of 2.0 percent. Its latest hike in August brought the key rate to 3.0 percent and financial markets are betting on a policy rate of about 3.5 percent at year-end.

Germany, Europe's sleeping giant, came alive this year with an acceleration which, combined with an even stronger showing by France, caught the IMF and most forecasters by surprise.

The IMF predicted growth of 2.0 percent in Germany this year after just 0.9 percent in 2005, but it predicted a significant dip next year to 1.3 percent, as the IMF is worried about the fallout from a rise in VAT sales tax.

Euro zone growth spurted an annualised 3.6 percent in the second quarter, the latest period for which results have been published.

A strong first-half performance means the region is set to record its strongest GDP rating since 2000.

The IMF forecasts were a touch lower than others.

The European Commission raised its euro zone growth forecast earlier this month to 2.5 percent from 2.1 percent, while the OECD jacked its prediction to 2.7 percent from 2.2. Both of those bodies are due to issue 2007 forecasts in November.

REUTERS VJ PM0824