* Inflation at 0.5 pct in March, below expectations
* Surprise drop raises chance of ECB rate cut on Thursday
* Economists caution inflation may have hit bottom
(Adds comment on inflation trend, ECB details)
By Robin Emmott and Philip Blenkinsop
BRUSSELS, March 31 Euro zone inflation hit its
lowest level since November 2009 in March, a shock drop that
raises expectations the European Central Bank will take radical
action to stop the threat of deflation in the currency bloc.
Annual consumer inflation in the 18 countries sharing the
euro was 0.5 percent in March, with the pace of price rises
cooling from February's 0.7 percent reading, the EU's statistics
office Eurostat said on Monday.
Economists polled by Reuters had predicted a 0.6 percent
reading - itself worrying for an economy that is barely pulling
out of a record-long recession after a crisis that nearly broke
up the currency area.
The euro zone is far from the deflation that Japan suffered
from the early 1990s, when falling prices weakened demand,
leading to wage cuts and even lower prices, but the bloc's low
inflation rate is a clear sign of economic fragility.
Inflation has now been in the ECB's "danger zone" of below 1
percent for six consecutive months, and the flash reading
increases the chances the ECB will cut interest rates when its
Governing Council meets on Thursday. Speculation has also grown
that it may employ other easing measures such as a negative
deposit rate or even U.S.-style bond-buying.
But this year's late Easter, which has delayed the impact of
rising travel and hotel prices at a time when many people go
away in Europe, could encourage the euro zone's central bank to
wait until its June meeting to act.
"This will keep the possibility of further monetary policy
easing very much alive," said Nick Kounis, head of economic
research at ABN AMRO in Amsterdam. "Nevertheless, the central
bank has shown quite some tolerance for low inflation recently."
The ECB, which targets inflation of just below 2 percent,
left borrowing costs unchanged at 0.25 percent in March and has
argued that deflation risks in the bloc are limited.
For a GRAPHIC on inflation: link.reuters.com/kuj24s
For a TABLE on inflation:
Some euro zone members, like Ireland, Cyprus and Greece have
experienced falling prices in recent months. For the bloc as a
whole, price rises for industrial goods outside the energy
sector were very modest in March, a sign demand remains weak.
On Monday, the International Monetary Fund's top European
official said the ECB had more room to cut interest rates to
counter risks from low inflation, although he said the Fund did
not see deflation setting in.
"We are not so much worried about deflation by itself, but
we are very worried about what we call 'low-flation'," said Reza
Moghadam, Director of the IMF's European Department.
"There is more room for further (ECB) easing, not least
because inflation is under control."
ECB President Mario Draghi suggested after the ECB's March
meeting that the bank will either do nothing or take bold action
should the outlook deteriorate.
He has also said the bank has been preparing additional
policy steps to guard against possible deflation, and that the
longer inflation remained low, the higher was the probability of
deflationary risks emerging.
The relentless weakening trend may focus minds, especially
after the head of Germany's powerful central bank came out to
discuss some of the bolder options in more detail, for example
pumping more money into the economy via a bond-buying programme.
"There's still a case for easing, but we don't think there's
going to be enough agreement within the Governing Council
members to ease on Thursday," said Guillaume Menuet, an
economist at Citigroup in London.
One factor that may temper the ECB's response is a sense
among economists that inflation has hit bottom and will rise in
the coming months. Commerzbank's Christoph Weil said he expected
consumer prices to be back at 0.9 percent in April, noting the
late Easter and also stabilising food and energy prices.
(Writing by Robin Emmott; Editing by Catherine Evans)