European Inflation Slows to Two-Year Low on Energy

By Jurjen van de Pol

Jan. 15 (Bloomberg) -- Europe’s inflation rate dropped to the lowest in more than two years in December as energy prices fell and consumers cut spending, giving the European Central Bank scope to lower interest rates to tackle the deepening recession.

The inflation rate in the euro area fell to 1.6 percent from 2.1 percent in November, the European Union statistics office in Luxembourg said today. The December rate was the lowest since October 2006 and matched the initial estimate published on Jan. 6.

As the euro-zone economy contracts and energy costs decline amid slackening demand, ECB policy makers meeting in Frankfurt today may lower the benchmark lending rate by half a percentage point, according to a Bloomberg survey of economists. Crude-oil prices have dropped 75 percent from a record $147.27 a barrel in July and energy costs fell 3.7 percent in December, the first annual decline since August 2007, today’s data showed.

Energy and food prices “will remain the main driver for the next few months and will exercise a significant drag on inflation,” said Luigi Speranza, an economist at BNP Paribas in London.

The ECB forecasts inflation will average 1.4 percent in 2009 and 1.8 percent next year, compared with 3.3 percent in 2008. The central bank also predicts the economy will contract about 0.5 percent this year, which would be the first full-year drop in gross domestic product since the euro’s launch a decade ago.

Key Rate

Slowing inflation may prompt the central bank’s governing council to lower the key rate to 2 percent today, according to the median forecast of 60 economists surveyed by Bloomberg. That would match the lowest rate since the ECB took charge of monetary policy in 1999.

The ECB “will have to go beyond this and I think it will go another 50 basis points in March,” Thomas Mayer, Deutsche Bank’s chief European economist, said in a Bloomberg television interview today. “We see the bottom closer to 0.75 percent than to 2 percent” for the key rate.

The ECB trails other central banks including the U.S. Federal Reserve and the Bank of England, which have reduced borrowing costs aggressively to combat the recession. The Frankfurt-based bank will announce its rate decision at 1:45 p.m. and ECB President Jean-Claude Trichet is scheduled to hold a press conference 45 minutes later.

In Germany, Europe’s largest economy, automaker Opel this month cut prices on some models by more than 8 percent and rolled out a cheap financing package to boost demand. German car sales fell 6.6 percent last month, capping the worst year since the nation’s reunification in 1990.

The German economy may have contracted as much as 2 percent in the fourth quarter, data showed yesterday. That would be the biggest slump in more than two decades.

The euro was little changed against the dollar after the inflation report, trading at $1.3183, down 0.1 percent, at 11:55 a.m. in London.

To contact the reporter on this story: Jurjen van de Pol in Amsterdam jvandepol@bloomberg.net