Euro zone in recession, December rate cut expected

BRUSSELS (Reuters) - The euro zone economy has fallen into its first recession, data showed on Friday, boosting expectations that the European Central Bank will cut interest rates again in December as inflation continues to fall quickly.

The economy of the 15 countries using the euro shrank 0.2 percent in July-September, as it did in April-June. This was the first time since the bloc's creation in 1999 that its economy has contracted in two consecutive quarters, the definition of a recession.

"Unfortunately, it is only the beginning," said Gilles Moec, economist at Bank of America, pointing out that the third quarter numbers did not fully reflect a severe worsening of the global financial crisis in September and October.

"We can expect further quarters of negative GDP growth, until the third quarter of 2009, simply because so far we have not had in the GDP figures the full impact of the credit market crisis," he said.

Leaders of the G20 industrialized and emerging economy nations are gathering in Washington to discuss ways of alleviating a world economic downturn and preventing a repeat of the financial crisis which spawned it.

Euro zone economic output grew by 0.7 percent in the third quarter from a year earlier, half the rate in the second quarter, according to Friday's data. This was weaker than in the United States, where output fell 0.1 percent on the quarter and grew by 0.8 percent in annual terms.

"Now the recession has been confirmed, the debate is concentrated on its length and severity. It seems that the current financial crisis is going to affect more significantly the real economy than initially anticipated," said Maryse Pogodzinski, economist at JP Morgan.

Carmaker Renault said in September it was cutting 6,000 jobs and Adecco, the world's biggest staffing agency, said in October it planned to cut up to 600 jobs in France and would merge about 75 branches as slowing economic growth forces it to cut costs.

"We do not expect renewed growth of the euro zone economy until the second half of 2009, when ECB rate cuts will gradually start to have a visible positive effect," said Christoph Weil, economist at Commerzbank.

ECB SEEN CUTTING RATES IN DEC

The ECB has cut interest rates by a total of one percentage point since early October to 3.25 percent, to boost financial market confidence as inflationary pressures wane along with the sharp slowdown in economic activity.

"The ECB will probably cut the key interest rate to 1.75 percent by next spring," Weil said.

ECB Executive Board member Juergen Stark told German radio on Friday that President Jean-Claude Trichet had not ruled out lowering interest rates further.

ECB Governing Council Member Athanasios Orphanides also said further rate cuts should not be considered unlikely. The bank's staff economic growth forecasts, to be released in December, would be much more pessimistic while the inflation outlook was much more favorable.

The ECB aims to keep inflation below, but close to 2 percent over the medium term. It was thrown off track by a sharp rise in oil and food prices in the 12 months to July, but oil prices have since dropped to a third of their July peak.

Eurostat data showed euro zone consumer prices were unchanged in October against the previous month and the annual rate of inflation slowed to 3.2 percent from September's 3.6 percent, mainly thanks to falling energy costs.

The annual measure of inflation that excludes volatile energy and unprocessed food components slowed to a 2.4 percent from 2.5 percent in September, signaling lower risk that wages would rise in response to the past oil price increases.

"We expect the ECB to take interest rates down to 2 percent by the middle of next year, with the next move likely to be a 50 basis point reduction in December," said Nick Kounis, economist at Fortis.

The quarterly euro zone GDP decline was prompted mainly by recessions in its biggest economy, Germany, and third-biggest, Italy. [ID:nBRM000090]. The second-biggest economy, France, defied market expectations of a similar fate, growing 0.1 percent in the third quarter.

The fourth-biggest economy, Spain, suffered its first contraction in 15 years in the third quarter, shrinking 0.2 percent. The European Commission expects the country to be in recession after an expected fall in fourth quarter GDP.

The slowdown is not just confined to the euro zone's biggest countries. The Dutch economy failed to grow in both the second and third quarters and Austrian growth slowed to 0.1 percent in the third quarter from a revised 0.3 percent in the second.

(Additional reporting by Marcin Grajewski and Ingrid Melander)

(Reporting by Jan Strupczewski, editing by Dale Hudson, David Stamp)