Turn in inflation boosts ECB rate cut expectations

Wed Jan 4, 2012 10:06am EST
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By Marc Jones

FRANKFURT (Reuters) - Euro zone inflation dropped below 3 percent for the first time in three months in December, kicking off a slowdown economists expect will revive deflation fears and tempt the ECB to cut rates below 1 percent for the first time in its history.

Official Eurostat figures estimated that consumer prices in the 17 countries sharing the euro rose 2.8 percent year-on-year in December, down from 3.0 percent year-on-year rises in November, October and September.

Following the recent souring of the European and global economy, economists widely share the view that inflation has now peaked and predict a short, sharp slowdown in the months ahead to back below the 2 percent sweetspot the European Central Bank judges to be optimal for a healthy economy.

As Eurostat's figures are only an estimate at this stage no detailed break-down of the inflation numbers is available. The slowdown was widely expected by analysts with most putting it down to lower energy and steadier food prices. "Assuming that the oil price does not rise again, we see this component knocking about 1 percent off the headline rate in 2012. Food inflation should also slow as the effects of past rises in agricultural commodity prices fade," said Ben May, economist at Capital Economics.

"We expect the headline inflation rate to plunge well below the ECB's 2 percent price stability ceiling by the middle of the year."

A new poll of economists by Reuters on Wednesday showed a clear majority now see the ECB cutting interest rates below the 1 percent mark for the first time ever in the next few months, although fewer than a third seeing it printing money in the way the U.S. and UK central banks are.

The bank has made back-to-back 25 basis points cuts since Mario Draghi took over as president in November. It has also gone back into full crisis mode, firehosing strained euro zone banks with almost half a trillion euros of ultra-cheap three-year loans and loosening its borrowing rules yet further.