Euro zone sentiment falls, Feb inflation could rise
BRUSSELS (Reuters) - A steep fall in February economic sentiment highlighted risks to euro zone growth on Friday, adding to market belief the ECB would cut rates later this year even if inflation sets new record highs in February.
Sentiment fell to 100.1 from January's 101.7, a monthly survey by the European Commission showed -- a much steeper dip than the decline to 101.2 expected by economists in a Reuters poll and the lowest reading since December 2005.
Separately, however, the European Union's statistics office Eurostat said inflation in the 15 countries using the euro fell 0.4 percent month-on-month in January for a record annual surge of 3.2 percent, driven by food and energy prices.
February data from Germany, Italy, Spain and Belgium pointed to a possible rise in inflation in the whole euro zone this month to a new record of 3.3 percent, economists said.
"The latest euro zone data provide further evidence of a slowdown in economic activity alongside strong price pressures," said Jennifer McKeown of Capital Economics.
This makes life difficult for the European Central Bank, which wants to keep inflation just below 2 percent, but has not raised interest rates because of signs the economy was slowing and because it expects the high inflation to be temporary.
Yet German February inflation defied expectations of an easing and remained at 2.8 percent. Price growth in Italy stayed at a record high of 3.1 percent and at 4.4 percent in Spain. Belgium reported inflation at 16-year highs on Thursday.
"We believe that euro zone growth will slow markedly over the coming months and that this will dilute underlying inflationary pressures and eventually compel the ECB to cut interest rates rather than raise them," said Howard Archer, chief European economist at Global Insight.
ECB DILEMMA
Economists also saw some inflation relief in a measure in the January data that excludes energy and food costs as well as alcohol and tobacco. That reading eased to 1.7 percent in annual terms from 1.9 percent in December.
"We have a nice slowdown in core inflation, and that plays into the hands of the ECB doves as it suggests we see no second-round effects for the time being, with the ECB coming gradually to terms with cutting rates," said Gilles Moec, economist at Bank of America.
Eurostat will release its flash estimate of February inflation on Monday, ahead of a monthly meeting between ECB President Jean-Claude Trichet and euro zone finance ministers who will discuss economic growth prospects, key for ECB rates.
The European Commission last week cut its forecast for 2008 growth in the euro zone to 1.8 percent from 2.2 percent. Economists expect the European Central Bank to follow suit when it presents its own growth forecasts on March 6.
The Commission survey showed the February decline in sentiment was driven by falling optimism in the services sector, which generates more than two thirds of the 15-member single currency area's gross domestic product.
"(This) is worrying given the importance of the sector to the overall euro zone economy. This heightens concern about the strength of euro zone domestic demand going forward," said Archer. Continued...
