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Inflation in Europe accelerated more than economists forecast, eroding consumers' spending power and adding to pressure on the European Central Bank to increase borrowing costs even as economic growth cools.

The inflation rate in the euro area rose to 4 percent this month, the highest in more than 16 years, from 3.7 percent in May, the European Union statistics office in Luxembourg said today. Economists had forecast a 3.9 percent rate for June, according to the median of 38 estimates in a Bloomberg survey.

Inflation-linked bonds fell on the data, signaling investors expect faster price increases over the long term even after ECB President Jean-Claude Trichet last week indicated his support for the so-called hawks on the governing council who argue rising inflation risks require higher interest rates. The price gains stemming from record oil and commodities are clouding the outlook for economic growth in the 15 nations that use the euro.

“It's a bad figure,'' EU Economic and Monetary Affairs Commissioner Joaquin Almunia said in Brussels today. “I wouldn't be surprised if the inflation figure for 2008 turns out to be above our forecast'' of 3.2 percent.

Europe's inflation rate has crossed “a psychological threshold,'' said Gilles Moec, an economist at Bank of America in London. “This will make it easier for the hawks to argue a rate increase is needed.''

Breakeven Rate

Investors' expectations of future inflation, as gauged by the breakeven rate on five-year inflation-linked French government bonds, rose to a record 2.67 percent following today's report, up from 2.57 percent yesterday.

“A change in long-term expectations is bad news for the ECB,'' Moec said. “That's what they are really looking at.''

Crude-oil prices have doubled in the last 12 months and passed $143 a barrel for the first time today. Food commodities have also surged in the past year, boosting how much consumers are paying for staples such as bread and milk.

Inflation in Italy, the euro region's No. 3 economy, also accelerated more than economists expected in June to 4 percent, the fastest in over 11 years.

“The surge in inflation is the reason why we've seen the economy lurching downwards,'' said Ken Wattret, senior economist at BNP Paribas in London. “The pipeline pressures are increasing and the news on the wage front has been very alarming.''

European retail sales plunged in June with the Bloomberg purchasing managers index falling to 44 from 53.1 in May. Consumer confidence is at record lows in France and Spain, while Germany and Italy also saw sentiment decline.

Energy Costs

Ludwigshafen, Germany-based chemical maker BASF SE is raising prices by as much as 20 percent and Dow Chemical Co., the largest U.S. chemical maker, by up to 25 percent to make up for surging energy costs. Rio Tinto Group said last week it agreed to increase iron-ore contract prices with Baosteel Steel Corp., China's largest steelmaker, by 80 percent to 97 percent.

Workers are demanding higher wages to compensate for the rise in the cost of living, a phenomenon central bankers refer to as “second-round effects,'' which risks setting off an inflationary spiral. Ground staff at Cologne-based Deutsche Lufthansa AG are calling for a 9.8 percent pay increase.

“The projections we have under our eyes are making the working assumption that we don't have broad-based second-round effects,'' Trichet said June 5. At the same time, policy makers “noted that risks to price stability over the medium term have increased further.''

The ECB this month raised its forecast for euro-area inflation next year to around 2.4 percent from around 2.1 percent. Inflation has exceeded the central bank's 2 percent limit the past 10 months.

The pace of price increases “is of deep concern,'' the EU's Almunia said. “We have to take care to avoid creating an inflationary spiral.''

The figures published today are an estimate. The statistics office will publish a detailed breakdown of the data and the core rate on July 16.

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