[LONDON] Investor expectations for long-term inflation in the single-currency bloc rose to their highest level in seven months on Tuesday, an encouraging sign for the European Central Bank as it prepares to step back from its extraordinary monetary stimulus.

Stronger economic growth in and outside the euro zone, a weakening in the single currency from recent 2-1/2 year highs and generally firmer oil prices help explain the move.

Strong business and bank lending surveys on Tuesday provided more evidence that the ECB will announce a trimming of its monthly bond purchases at a meeting on Thursday - pushing up bond yields and a key market gauge of future price pressures.

The five-year, five-year breakeven forward rate, an inflation measure closely tracked by the ECB, rose to 1.6571 per cent, the highest since March.

That is still below the ECB's near 2-per cent inflation target, but up from lows around 1.50 per cent set in June.

Europe's benchmark German 10-year bond yield - which is also very sensitive to changes in inflation expectations - rose 4 basis points on Tuesday to its highest in nearly three weeks.

"It does reflect surprisingly solid European data of late such as the PMIs," said Commerzbank strategist Rainer Guntermann, referring to business activity surveys.

"The ECB is signalling that it will do all that's needed to push inflation higher and an expectation of a soft exit from its stimulus scheme is also supporting inflation expectations." Any pick-up in inflation expectations is likely to be welcomed by the ECB, which is facing technical constraints in its asset-purchase scheme and looking for signs of both stronger growth and inflation to start scaling back its 2.3 trillion euro asset purchase programme.

It is widely expected to begin unwinding asset purchases in early 2018.

There are some other encouraging signs.

The euro has weakened almost 3 per cent from recent 2-1/2 year highs above US$1.20. Although the five-year, five-year forward rate was creeping higher before that in defiance of euro strength.

Data earlier this month meanwhile showed prices at the factory gate in the euro zone rose a stronger-than-expected 2.5 per cent year-on-year in August.

Jonathan Baltora, a portfolio manager at AXA Investment Managers, said a rise in oil prices in recent months was a key driver behind the pick-up in inflation expectations.

Oil prices, a key component of inflation indexes, have risen about 30 per cent from 2017 lows hit in June.

"I think that ECB is going to welcome the move," said Baltora, referring to the pick up in market inflation expectations.

"Euro zone inflation had flirted with zero in the past two years but if you look at core inflation that is now rising and we think it will continue to rise."

REUTERS