Interest rates could rise tomorrow when the governing council of the European Central Bank meets in Frankfurt following the euro's worst week on the financial markets since its introduction a year ago.
The broad consensus is that the ECB will wait until March before edging rates upwards but most German analysts are predicting that the central bankers will bring forward the move to tomorrow.
The euro regained some ground yesterday after four record lows in succession that saw the dollar valued at more than two deutschmarks for the first time in two decades. Analysts said rumours of active selling of the US currency against the Swiss franc by the Swiss authorities led to a weakening of dollar sentiment.
The IMF's managing director, Mr Michel Camdessus, also said last night that the euro was "too weak" and he predicted a rise in its value as the European recovery regained momentum in the next few months. He said the US current account deficit presented no immediate threat to monetary stability.
When the euro zone's central bankers came together in Frankfurt last month for the governing council's first meeting this year, they were in a cheerful, even self-congratulatory, mood. Economic prospects throughout the single currency area were looking rosy, inflation was under control and, after months in the doldrums, the euro had started to improve against the dollar on foreign exchange markets.
As the central bankers prepare to return to Frankfurt tomorrow, their mood could scarcely be more different. Little has changed on the economic scene and the recovery in Germany, Europe's largest economy, appears more robust than ever.
But the euro's grim performance on the financial markets in recent days has created a mood of panic in Frankfurt that has convinced most German analysts that the ECB will make a desperate effort to shore up the currency by raising interest rates tomorrow.
Until this week, most analysts were expecting the ECB to wait until March to raise interest rates, probably by half a percentage point. But a survey of German analysts this week showed that most now believe the bank will agree to an increase tomorrow.
The ECB President, Mr Wim Duisenberg, has long attempted to play down the significance of the exchange rate, arguing that improved economic growth and low inflation in the euro zone would eventually persuade investors that the new currency is undervalued. But he admitted this week that the euro's slide against the dollar is a threat that the ECB cannot continue to ignore.
"The exchange rate plays an important role in the strategy of the ECB and its further weakening could mean a risk to the ECB's goal of maintaining price stability," he said.
A weak euro helps European exporters by making their goods more competitive on the world market but it can fuel inflation by making imports more expensive. Mr Daniel Scheibler of Bank Sarasin believes the central bankers will conclude tomorrow that the risks associated with a weak euro now outweigh the benefits.
"The reason the ECB will raise interest rates is the booming euro countries. Employees in Spain, Portugal and Ireland want to be paid as workers are in the highly-paid countries. That contains inflationary potential," he said.
Most German analysts predict the bank will nudge rates upwards by a quarter of one percentage point, a departure from the ECB practice of making decisive moves of half a percentage point.
The central bankers' problem is that a sudden move on interest rates could encourage the markets to believe the ECB has been frightened into action.
