Euro zone inflation plunges, jumbo ECB rate cut seen

BRUSSELS (Reuters) - Euro zone inflation plunged in November and unemployment jumped more than expected, boosting the chances that the European Central Bank will make its largest ever interest rate cut next week to help a shrinking economy.

Consumer price inflation in the 15-country bloc fell 1.1 percentage points, the biggest drop since the euro zone was created 10 years ago, to 2.1 percent year-on-year, Eurostat statistics office estimated on Friday.

Market forecasts had centred on a decline to 2.3 percent and the actual inflation rate was only just above the ECB's target. This opened the way for a possible bold move by the ECB, which has never cut rates by more than 50 basis points in one step since it took over euro zone monetary policy in 1999.

"There will be further decline in inflation, and inflation is likely to fall below 1 percent in 2009, and it's not ruled out that the year-on-year rate may turn negative," said Juergen Michels, economist at Citigroup.

"That all gives the ECB ample room for rate cuts. We expect a cut by 75 or 100 basis points in December and further rate cuts next year. Our forecast is that the ECB rate will go down to 1 percent or even lower by mid-2009," he said.

The ECB wants inflation to be below, but close to, 2 percent and has said it has ample room to cut rates at its next policy meeting on December 4 if inflation pressures subside.

In a Reuters poll taken before the surprisingly large drop in inflation, most economists had expected a 50 basis point cut to 2.75 percent. But even then around a quarter of the forecasters see a deeper cut of 75-100 bps.

Market prices show traders have already fully priced in 75 basis point cut with a high risk of 100 bps.

The ECB has already cut rates twice by 50 bps, in October and November, as the euro zone sank into recession in the wake of the worst global financial market crisis since the 1930s.

This crisis is also pummeling countries outside the euro zone. Sweden slid into recession after the third quarter, data showed on Friday, and economists expect the Swedish central bank could slash rates also by an unprecedented 75-100 bps.

Japan's industrial output and household spending tumbled in October, evoking memories of the decade-long stagnation of the 1990s and highlighting how rapidly the global financial crisis is derailing major economies.

Countries as diverse as Canada, India and South Korea also released figures painting a bleak economic picture, but stocks edged higher as investors tentatively looked for bargains after six months of falls for global equity markets.

CHEAPER OIL DRIVES DOWN INFLATION

No monthly data or a detailed breakdown was available with the Eurostat estimate, but economists said a sharp drop in oil prices was the main reason behind the fall in annual inflation.

Between October and November oil prices fell more than 12 euros per barrel, which is likely to have reduced energy price inflation by around 10 percent, BNP Paribas economist Clemente de Lucia said.

Germany, the euro zone's biggest economy was likely to have been one of the biggest contributors to the consumer price deceleration, earlier data showed. Its rate fell 1 percentage point this month to 1.4 percent year-on-year.

Economists noted the drop in euro zone price growth was likely to fuel concerns that the common currency area might see deflation next year, but said chances of that were still low.

"Even if inflation approaches zero in the course of 2009, we regard the risk of deflation as still very low," said Christoph Weil, economist at Commerzbank.

"We are still a long way from falling prices across the board in the euro zone. The market still expects rising prices. Judging by the 5-year forward break-even inflation rate based on inflation-linked swap rates, a medium-term inflation rate of 2.25 percent is expected," he said.

UNEMPLOYMENT ON THE RISE

Eurostat also said euro zone unemployment rose to 7.7 percent in October, its highest level since January last year, from an upwardly revised 7.6 percent in September.

While a lagging indicator, the rising unemployment is likely to ease inflationary pressures further in the euro zone economy, which contracted in the second and third quarters and is seen shrinking even faster in the fourth.

"Increasingly deteriorating labor markets will ... weigh down on euro zone consumer spending, countering the boost to purchasing power ... from sharply retreating inflation," said Howard Archer, economist at IHS Global Insight.

"Rising unemployment will increasingly undermine workers' bargaining power ... and ensure that wage moderation continues despite recent extended high inflation," he said.

The biggest unemployment increases were in Spain, where the rate went up to 12.8 percent from 12.1 percent in September, and in France, where it rose to 8.2 percent from 8.0 percent.

(Additional reporting by Gavin Jones in Rome, Andrew Hay in Madrid, Tomasz Janowski in Singapore, Francois Murphy in Paris, Ingrid Melander in Brussels and Adam Cox in Stockholm)

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