Eurozone inflation drop fuels talk of rate cut

LONDON - The pressure on the European Central Bank to cut interest rates again ratcheted up on Friday after figures showed inflation unexpectedly falling further below its target.

Eurostat, the EU's statistics office, said inflation in the 18-country eurozone fell to 0.7 percent in the year to January from 0.8 percent the previous month.

The fall was unexpected -- the consensus in the markets was for a modest rise to 0.9 percent -- and has reinforced fears that the eurozone is about to suffer a Japanese-style bout of deflation, which can be very difficult to get out of. Once prices start to fall, economies can become moribund as consumers delay purchases in the hope of getting bargains later and businesses postpone investment and innovations.

The ECB will hold its monthly policy meeting on Thursday and a growing number of economists think it may ease monetary policy further in response to these deflation fears, which are accompanied by concerns over muted growth and sky-high unemployment. Unlike the U.S. Federal Reserve, which tries to keep both price increases and unemployment low, the ECB only has one mandate -- to make sure inflation is stable at just below 2 percent.

"We do not think the Governing Council will have yet reached the point at which it is ready to act immediately, though that cannot be ruled out," said James Ashley, chief European economist at RBC Capital Markets.

Barring any unforeseen bounce-back in inflation over the next month, Ashley thinks the ECB will be ready to act at its meeting in early March, possibly by cutting the main rate to 0.10 percent from the current record low of 0.25 percent.

Other economists think it may decide to make its deposit rate negative, a move that would essentially make banks pay to have their money parked at the central bank. That, the theory goes, may make them lend more, which would shore up economic activity and stimulate inflation.

The ECB could also offer banks another round of long-term loans, though recent comments from ECB President Mario Draghi suggest that's not imminent. A U.S.-style monetary stimulus, in which the amount of money in the economy is increased, is considered a long-shot, largely because of Germany's historic reluctance.

Some sort of action is expected, given that inflation is expected to fall further this year amid weak cost pressures, high levels of spare capacity and the elevated value of the euro, which keeps a lid on import prices. And if oil prices fall further -- they were a key factor behind the January fall -- some economists think deflation is a real possibility.

"We continue to think that rate cuts are somewhat more likely than other options," said Joerg Kraemer, chief economist at Commerzbank. "However, the bank will probably not yet act this coming Thursday, as the latest economic sentiment indicators have proved rather better than envisaged."

Separately, in a positive development, Eurostat said eurozone unemployment fell by 129,000 in December to 19.01 million. The decline was the biggest fall since April 2007 and largely due to an 81,000 drop in Spain, which many economists think is on the mend following wide-ranging labor market reforms.

The overall unemployment rate in the eurozone, however, was unchanged at 12 percent.

Despite those signs of improvement, unemployment across the eurozone is still not far off its all-time high of 12.1 percent. The overall figure also masks huge divergences between countries. While Germany and Austria have unemployment rates around 5 percent, Greece and Spain still have more than one in four people out of work.

The situation among the young is even starker, with the youth unemployment rate in Greece up at 59.2 percent in October, the last month for which figures were available. Spain, though, saw its youth unemployment rate fall to 54.3 percent in December from 55.2 percent, as the number of under 25 year olds out of work fell by 20,000.