UPDATE 2-German inflation dips; boosts ECB rate cut hopes

Thu Oct 27, 2011 9:10am EDT

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* Annual inflation 2.5 pct in Oct, vs 2.6 pct in Sept

* Still well above ECB target, but trend downwards

* Strengthens case for near-term ECB rate cut

By Sarah Marsh

BERLIN, Oct 27 (Reuters) - German annual inflation unexpectedly slowed in October, strengthening the case for a growth-boosting interest rate cut by the European Central Bank in the near future as the region's economy weakens.

Prices still rose 2.5 percent on the year -- well above the ECB's target of just under 2 percent. But this was mostly due to energy prices, the Federal Statistics Office said on Thursday, and down from a reading of 2.6 percent in September when inflation jumped unexpectedly to a three-year high.

"The latest decline in the annual headline rate likely marks the cyclical peak in consumer price inflation," said UniCredit's Alexander Koch. "Another temporary uptick in the short term cannot be ruled out. But leading price indicators suggest an imminent turnaround in the price dynamic."

Inflation was unchanged on the month after accelerating 0.1 percent in September. A Reuters poll of economists had forecast inflation to continue accelerating at 0.1 percent on the month and 2.6 percent on the year.

Consumer prices harmonised to compare with other European Union countries were unchanged month-on-month and gained 2.8 percent year-on-year. In September, prices had risen 0.2 percent and 2.9 percent, respectively.

ECB POLICY DILEMMA

For much of the year, the ECB has faced the dilemma of balancing monetary policy for Germany's strong economy and struggling peripheral euro zone states.

Wages have risen this year as Europe's largest economy expanded faster than expected and unemployment dropped, raising fears of second-round inflation effects.

Next year, pensions could rise 2.3 percent and 3.2 percent in western and eastern Germany, the country's pension insurance association said on Thursday. Pensions rose only 1 percent this year, and the government will determine their 2012 increase early next year.

But economists see inflation decelerating as the economy cools due to a global slowdown and uncertainty in the face of the euro zone debt crisis impacting investment and exports.

German industry orders and output are slumping, and business sentiment slid for the fourth month in a row in October, dipping to its lowest level since mid-2010.

Furthermore, several ECB policymakers have said recently that slowing economic growth in the euro zone as a whole was of greater concern than inflation.

According to a Reuters poll of 70 economists published on Tuesday, the region's economy now faces an even chance of falling back into recession and the ECB will move to support it by cutting rates to 1.25 percent, mostly likely in December but possibly as early as next week.

"Several factors make an ECB rate cut desirable: we expect inflation to decline over the course of next year as last year's steep increases in energy cost drop out of the equation," said Christian Schulz, economist at Berenberg Bank.

The German government forecast this month inflation would decelerate to 1.8 percent next year from 2.3 percent this year.

"The weaker economic development should check upward pressure on prices. In addition, (European) bank recapitalisation efforts could put pressure on credit availability and hamper the economic development in the euro area," Schulz said.

"In these circumstances, a rate cut could have a positive growth impact without shifting inflation risks to the upside," he said, noting this would likely happen in December.

Germany's flash inflation estimate is based on data from six of the country's 16 states, which make up more than half the population.

In five of the six states, annual inflation accelerated in October, but in Germany's most populous state of North Rhine-Westphalia it eased on a large cut in tuition fees.

Final German price data for October are due for release on Nov. 10, the office said.

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