European Inflation Slows as ECB Prepares for Rate Cut

By Fergal O'Brien

Oct. 31 (Bloomberg) -- Europe's inflation rate declined to the lowest since January as the European Central Bank prepares to cut interest rates for the second time in less than a month in response to the financial and economic crisis.

Inflation in the euro area eased to 3.2 percent in October from 3.6 percent in September, the European Union statistics office in Luxembourg said today. That matched the median of 27 economists in a Bloomberg News survey. A separate report showed unemployment stayed at 7.5 percent in September, the highest in more than a year.

The ECB unexpectedly cut its key rate by half a percentage point to 3.75 percent on Oct. 8 as part of a coordinated global action. ECB President Jean-Claude Trichet said Oct. 27 the bank may follow that emergency cut with another reduction at its Nov. 6 meeting and fellow policy maker Miguel Angel Fernandez Ordonez said the sharp drop in inflation is ``very important.''

``Lower inflation plus the gloomy economic outlook will dampen inflation expectations,'' said Christoph Weil, an economist at Commerzbank in Frankfurt. ``The ECB will continue to cut interest rates rapidly over the coming months.''

The figures released today are an estimate. The statistics office will publish a detailed breakdown of the data, including key food- and energy-price inflation, as well as the core rate, on Nov. 14. Crude-oil prices have dropped by 57 percent from their all-time high in the last four months, cutting the cost of gasoline and heating oil. From a year earlier, oil is down 32 percent to around $64 a barrel.

Core Inflation

``Previous sharp increases in costs and the earlier strength of the labor market might still prompt wage growth and core inflation to rise,'' said Jennifer McKeown, an economist at Capital Economics in London. Still, rising unemployment means ``any pick-up in core inflation will not last too long.''

McKweown sees inflation easing to below the ECB's 2 percent ceiling in the first half of 2009. Consumer-price growth has been above that target in every month since September 2007.

As the growth outlook deteriorates and inflation continues to ease, economists at banks including Capital Economics and Royal Bank of Scotland Plc say the ECB will cut its benchmark rate to at least 2.5 percent by mid-2009.

Recent data show that Europe's manufacturing and services industries contracted at a record pace in October, while executive and consumer confidence plunged to the lowest in 15 years. The interest-rate cut this month was the ECB's first since June 2003 and it followed an increase of one-quarter percentage point in July.

`Have Accentuated'

ECB Executive Board Member Jose Manuel Gonzalez-Paramo said this month that downside risks to economic growth ``have accentuated'' and Governing Council member Nout Wellink said growth in Europe may stagnate next year.

``Growth is more likely to be closer to 0 percent than 1 percent next year,'' Wellink said in The Hague yesterday. The global economy ``is looking worse than a month ago.''

To contact the reporter on this story: Fergal O'Brien in Dublin at fobrien@bloomberg.net.