Economic growth in the eurozone reached an annual rate of 3.4 percent in the first half of the year, the highest level for six years, the European Commission announced Monday.

"Domestic demand has finally bounced back and has become the main source of growth. In a context of improving labour market and easing oil prices, the economic outlook could turn out better than expected in the near term," according to the commission's quarterly report on the euro area.

"The recovery of the euro-area economy appears to be on solid ground, with GDP growing in the first half of the year at a pace not seen in the last six years," the report said.

Growth over the whole of 2006 in the 12-nation eurozone is now forecast at 2.5 percent, 0.4 percentage points above a previous forecast.

The data was expected to provide further justification for the European Central Bank to raise interest rates when it meets in Paris on Thursday.

Further ahead, however, the commission report warned of downside risks, citing turbulence in global financial markets earlier this year as evidence of dangers in the "macro-financial environment".

Structural reforms and wage moderation within the 12 nations that use the euro currency have boosted the economy's employment performance.

"Nevertheless, there is scope to further improve the functioning of labour markets. That past efforts are paying off should encourage further steps in the right direction," the commission said.

Buttressed by a strong rebound in private investment, domestic demand took over as the main source of strong growth. With the recent ebbing of oil prices and the gradual firming of the labour market, prospects for private consumption, a particularly weak spot in the euro area in recent years, are also improving, according to the report.

However structural unemployment remains high, the long-term unemployed continue to represent a large share of the total number of jobless, and job creation is dominated by temporary contracts.

"All this calls for member states to step up their efforts," the commission warned.

Other figures published Monday showed the eurozone's manufacturing base expanded in September, showing growth for the third consecutive month and beating analysts' expectations.

NTC Economics' eurozone manufacturing sector purchasing managers' index (PMI) remained steady at 56.6 points, confounding the expectations of the experts for slight drop to 56.5 points.

A reading above 50 signals that the sector is expanding.

"Following on from the very strong eurozone economic sentiment data for September, the manufacturing PMI adds to the evidence that the eurozone economy currently remains buoyant," Global Insight economist Howard Archer said.

The European Central Bank is set to raise its key interest rates for the fifth time in 10 months at its meeting in Paris on Thursday, despite signs that inflationary dangers in the eurozone are easing as oil prices come off their highs, analysts agreed.

"At the moment the eurozone is enjoying a solid and balanced economic upturn which is not generating significant inflationary pressure," said Holger Schmieding, an economist with the Bank of America.

However the confidence this brings is likely to persuade the central bank to increase interest rates.

"Consumers have become more optimistic about the short-term economic perspective," Schmieding added.