The European Central Bank will show its determination to check firming price pressures at its meeting on Thursday with markets focusing on whether it uses the strong vigilance codewords to signal a rate rise in June.
No change in interest rates is expected after the ECB's policymaking Governing Council's meeting in Helsinki, which began at 0700 GMT, so markets will scrutinize ECB President Jean-Claude Trichet's language.
If Trichet uses the phrase, which he deployed in March to flag a 25 basis point rate rise in April, markets will price in the next hike in June. If he does not, they expect it in July.
In the past, the ECB regularly used the strong vigilance phrase to signal a hike was only a month away.
The Frankfurt-based bank raised euro zone rates to 1.25 percent last month, ending almost two years of record-low interest rates and beginning what economists expect to be a run of increases.
We're looking for the ECB to very clearly signal that they intend to hike rates in June, said Societe Generale economist James Nixon.
We are looking for the key code words 'strong vigilance' and for a statement that risks to price stability are still very much on the upside, he added, predicting the bank's next staff forecasts -- due in June -- would show accelerating inflation.
Economic data released since the April meeting has shown euro zone inflation accelerating to 2.8 percent in April. The ECB aims to keep it just below 2 percent over the medium term.
A Reuters poll last Thursday showed a majority of 76 economists expected the next hike in July.
The meeting in Helsinki comes just two days after Portugal announced it had reached preliminary agreement with the EU, IMF and the ECB for a three-year package of support, including help for Lisbon's banks.
Portugal's bailout highlights the battle euro zone weaklings face while the bloc's core economies, like Germany, enjoy a robust recovery.
That, and speculation about a possible Greek debt restructuring, is unlikely to blow the ECB off course, however, as it exits the loose monetary policy it employed from October 2008 in response to the global financial crisis.
If anything the Portuguese package is a positive development for the market in the sense that that removes another source of uncertainty for the time being, said Nixon. The sense is that the sovereign debt crisis is abating again and that the ECB can continue to respond to inflation.
NEW BOY, OLD STANCE
Thursday's meeting will be the first attended by incoming Bundesbank chief Jens Weidmann, who on Monday stuck to the hawkish policy stance of his predecessor, Axel Weber, by saying monetary policy must be normalized.
In his first comments on monetary policy, Weidmann said it was a question not of 'if' but rather 'when'.
ECB policymakers have been at pains to stress the separation of their standard policy tools -- interest rates -- from non-standard measures, including the unlimited liquidity operations they use to help banks in the periphery that are frozen out of interbank markets.
The ECB said in March it would carry on providing unlimited funding for banks at its three-month operations through to the end of June and would keep full allotment at its weekly and one-month operations, until at least July 12.
With the liquidity taps still on, the periphery's woes are unlikely to stop the ECB flagging a further rate rise.
The stronger-than-expected inflation April reading, together with a survey showing factories in the euro zone ramped up production in April, have led a number of economists to lean toward a June hike.
Nomura's Jens Sondergaard saw only a 30 percent probability of a June rate rise.
If they sound the strong vigilance alarm tomorrow and hike in June, they are implicitly sending a signal to the market that they are keen to hike ... and that will push up market expectations even further, and will push up the euro, he said.
The euro has raced higher since the April meeting, closing in on $1.50 as the ECB focuses on tackling inflation while the Federal Reserve has signaled it is in no hurry to scale back its support for the U.S. economy.
(Writing by Paul Carrel, editing by Mike Peacock)