MiddletownJournal.com

Euro zone inflation fell below target in December

BRUSSELS, Belgium — Inflation in the countries that use the euro currency dropped further in December to 1.6 percent, according to official estimates, stoking market expectations that the European Central Bank will keep cutting borrowing costs in coming months.

The European Union's Eurostat said annual inflation dropped from 2.1 percent in November and 3.2 percent in October as oil prices continued to tumble.

December's reading means inflation has fallen below the European Central Bank's target of "close to, but less than 2 percent" for the first time since August 2007.

Though Eurostat did not provide a breakdown for the decline in inflation, analysts reckon that it reflected in large part further falls in energy prices following the steady drop in the price of crude to around $40 a barrel. As recently as July, oil prices were $147 a barrel.

Because of year-on-year base effects, many analysts actually think inflation in the now 16-nation single currency zone — on Jan. 1, Slovakia became the latest country to join the euro — may actually turn negative for a while later this year.

"In all then, the latest data support our view that euro-zone inflation will undershoot the ECB's inflation target for a sustained period," said Ben May, European economist at Capital Economics.

And with economic activity data pointing to a deeper and more prolonged recession, investors moved to price in bigger interest rate reductions than previously predicted from the European Central Bank.

Earlier Tuesday the monthly purchasing managers' index for the then 15 euro nations fell to 42.1 in December, its lowest in the survey's ten-year history, from 42.5 in the previous month. A reading below 50 indicates contraction and the bigger the difference, the greater the contraction.

"Accordingly, we expect the ECB to continue to cut interest rates next week and for rates to be close to zero by the autumn," said Capital Economics' May.

Mounting expectations that the ECB will cut its benchmark rate by at least a quarter percent from the current 2.5 percent next week pushed the euro down 1.8 percent against the dollar to $1.3369 Tuesday.

However, some analysts cautioned about expecting too much from the European Central Bank, as the bank's chief Jean-Claude Trichet has suggested that he would prefer to pause and evaluate the cumulative impact of the 1.75 percentage point interest rate reductions that have been enacted since October.

Last month, Trichet said there was "an underestimation in the financial sphere of the very great importance of the decisions that were taken."

Simon Derrick, a currency strategist at Bank of New York Mellon, said markets may as a result be pricing in far more in the way of interest rate cuts than Trichet's guidance would suggest.

"As such we remain extremely cautious about the foundations for the current euro weakness," he said.

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