Euro zone inflation plunged more than expected to a 26-month low in December as the economy slowed sharply, data showed today, knocking back the euro on expectations of a deep ECB rate cut next week.
The European Union's statistics office Eurostat said inflation in the 15 countries using the euro in December was 1.6 per cent year-on-year, down from 2.1 per cent in November and well below the ECB target of just under 2 per cent.
Economists polled by Reuters had expected a decline to 1.8 per cent, and the lower number added to the case for a cut in interest rates to keep price growth from diving beneath the European Central Bank's target of below but near 2-per cent.
The euro plunged against the dollar to $1.3347 from $1.3440 in response to the data.
ECB rate cut expectations were also boosted by data showing the euro zone private sector services economy shrank sharply in December and firms cut more jobs than expected, pointing to a deep recession lasting for a good part of 2009.
The euro zone services sector generates some two thirds of the single currency area's gross domestic product and the PMI index, which covers banks to retail stores, fell to a new low in its 10-year history.
"With euro zone consumer price inflation falling below the ECB's target level, and the purchasing managers' survey pointing to record contraction in service sector activity, there is a compelling case for the ECB to cut interest rates significantly further," said Howard Archer, economist at Global Insight.
The ECB meets to discuss rates on January 15th. Markets have priced in a 50 basis point cut from the current 2.5 per cent, with some investors betting on a 75 basis point move after the last such reduction in December.
The bank has cut rates by 175 basis points since October as inflation decelerated rapidly from a July peak of 4 per cent along with a sharply slowing economy and falling oil prices.
"It makes it even more likely for the ECB to cut interest rates further in the next few months, starting in January and going to 1.5 per cent in March," said Holger Schmieding, co-head of Europe economics at Bank of America.
ECB President Jean-Claude Trichet has declined to give any firm indication on whether such rate cut bets are justified.
But ECB Governing Council member Vitor Constancio said on Monday the bank would respond with more rate cuts if necessary to keep inflation from falling too much below target.
The bank's Vice-President Lucas Papademos said on Sunday that more rate cuts may be needed to shield the euro zone economy and make sure inflation did not fall too far, stressing that deflation would be kept at bay.
"The balance of news from Europe is so poor that the market is perceiving that the ECB is behind the curve (on rates)," said Adam Cole, global head of currency strategy at RBC in London.
Reuters