Interest rates will rise in Europe this year, but fall in the the UK, suggests a new report from CIBC World Markets.

“Debates over monetary policy outlook can change dramatically over short periods of time and while early last year, [European Central Bank] rate cut talks and [Bank of England] rate hike talks dominated the scene, it will be a reversed story in 2006,” notes the report, which was released today.

“Indeed, while we expect the ECB to pursue the tightening of monetary policy that began last December, we are still of the view that BoE rate cuts are feasible this year.”

In 2006, CIBC says it expects the European Central Bank to continue the normalisation in interest rates initiated in December, “with a gradual adjustment likely to be favoured by the monetary authorities.”

This means that the ECB is likely to favour 25 basis point rate rises at a time, it predicts. “And while the Fed has opted to hike 25 bps per meeting, we expect the European monetary authorities to raise 25 bps per quarter (at most).” It expects a year-end rate at 3%, up 75 bps higher than its current level and with the peak in rates likely to be reached in the third quarter.

“This has to be seen as an adjustment towards what is considered to be a more neutral interest rate level, it is not an aggressive tightening of monetary policy,” it concludes. “The intention here is not to put a brake on growth but to contain any future inflation risk: after all, Eurozone real rates remain marginally negative.”

As for the UK, CIBC notes that the economy has been through a marked slow-down in activity in 2005, and it cautions that those hoping for a strong revival in growth in 2006 “could prove disappointed”. Instead, it says, “a trend GDP growth rate is unlikely to resume before 2007 and we would not rule out the Eurozone economy outperforming the UK this year.”

“We are still very much of the view that the next move in UK rates is more likely to be down than up, with a 25 bps cut in interest rates looking like a feasible scenario, possibly before the end of the first half of the year,” it says.

“The tone of the data due out in the next few weeks will prove key in determining the probability of a February or a March interest rate cut,” CIBC says, but there could be a case for the Bank to wait a little longer.

“We are also of the view that it may not be just one more rate cut for the BoE: a sub-trend growth environment/benign inflation picture may justify another rate cut later this year; with a year-end forecast at 4% for the repo rate,” it says.