Euro zone morale dips, boosts rate cut case

Brussels: Euro zone economic sentiment hit record lows in January and inflation expectations fell, data showed, boosting the case for more European Central Bank interest rate cuts as the economy sinks deeper into recession.

Economic sentiment in the 16 countries using the euro dropped to 68.9 points - the lowest since records began in 1985 - from an upwardly revised 70.4 in December, the European Commission said yesterday.

Before the revision, economists polled by Reuters had expected a fall to 65.8.

"Record low euro zone business and consumer confidence in January, a marked slowing in loans to the private sector and further clear evidence of dwindling inflationary pressures, reinforce the already strong case for another ECB interest rate cut," said Howard Archer, economist at IHS Global Insight. The ECB meets on interest rates next Thursday. The bank's president, Jean-Claude Trichet, has signalled markets should not expect another cut then, but that the next important rate-setting meeting would be on March 5.

Economists said what was a relatively small decline in January economic sentiment would play well with the bank's apparent intention to pause with cuts in February.

"Tentative signs of stabilisation in the pace of recession should be enough to keep the ECB on hold next week, but the need for further rate cuts is clear, in our view," said Aurelio Maccario, chief euro zone economist at Unicredit. The ECB wants to keep inflation expectations anchored at its target of below but close to 2 per cent over the medium term.

But the monthly Commission survey showed that inflation expectations among households fell again, to 5 points from 7 in December, close to an all-time low of 3 from April 2004. Among firms, inflation expectations set a record low of -11.

"While the ECB has hinted strongly that it will pause in cutting interest rates in February ... we expect another 50 basis points reduction to 1.50 per cent in March," Archer said.

The bank has cut interest rates by 225 basis points to 2 per cent since October as falling oil prices halved the rate of inflation in the same period and data pointed to an annual contraction of the economy of almost 2 per cent.

The euro zone economy is sinking deeper into its first recession because of the global credit crunch, which has slashed financing to companies and households, curbing demand and causing corporate belt-tightening. The EU statistics office, Eurostat, is due to release an initial estimate of euro zone January inflation today.