BRUSSELS/BERLIN (Reuters) - Inflation in the euro zone has fallen to a three-year low and unemployment has hit a new record, cementing expectations of an interest rate cut by the European Central Bank later this week.
With the bloc's economy mired in recession, inflation tumbled to 1.2 percent in April, the lowest level since February 2010 and the biggest monthly drop in more than four years, the European Union's statistics office Eurostat said on Tuesday.
That put the annual rate of increase in the cost of living well below the ECB's target of close to, but below 2 percent, raising pressure on the central bank to act to aid growth.
Euro zone unemployment meanwhile reached a record 12.1 percent of the working population in March.
EU leaders are already trying to shift away from the budget cuts that have dominated the response to the debt crisis since 2009, and the data will raise the specter of deflation as companies slash prices to entice shoppers.
But the European Commission, which polices countries' debts and deficits, defended its insistence on sustainable public accounts that many economists blame for deepening the two-year recession, saying it had "no austerity dogma".
"That is a caricature, our approach is a balanced one," said Commission spokeswoman Pia Ahrenkilde Hansen.
Cutting interest rates to a new record low of 0.5 percent would show investors the ECB is concerned about the poor state of the bloc's economy, but the Frankfurt-based bank faces a difficult balancing act accommodating a more resilient Germany.
German consumers were more upbeat going into May than at any point in the past 5-1/2 years and data showed the unemployment rate in April nearing post-reunification lows, a sign that consumers may be positioned to help drive a recovery.
"It's a close call, but we expect a rate cut this week," said Sarah Hewin, a senior economist at Standard Chartered Bank.
"With inflation weaker than expected, unemployment rising yet again and signs of a longer recession, it would be a confidence boost."
According to a Reuters poll last week, a narrow majority of economists expect a 25 basis point cut on Thursday at the ECB's meeting in Bratislava.
The ECB expects the euro zone's economy to start recovering in the second half of the year, but recent data has cast doubts on that forecast, especially with the German economy struggling to rebound strongly from its fourth-quarter contraction.
"The news that the euro zone will remain in recession again this year is clearly curbing economic optimism in Germany as well," said Rolf Buerkl of GfK market research group that published the May consumer climate data.
But a modest ECB rate cut is unlikely to be a game-changer because borrowing costs are already low, and in southern Europe banks are reluctant to lend to indebted households and to companies struggling to sell their goods.
Spain's economy shrank for the seventh straight quarter in the first three months of the year, figures showed on Tuesday, suggesting its recession will stretch into 2014.
French consumer spending - the driver of its economy - fell in the first quarter having declined for the first time in two decades last year.
Italy's new Prime Minister Enrico Letta added his voice on Monday to calls for a change to the EU's focus on austerity and more pursuit of economic growth and jobs.
Some economists and politicians say austerity creates a damaging cycle where governments cut back, companies lay off staff, Europeans buy less and young people have little hope of finding employment.
About 19.2 million people are now out of work in the bloc, the highest level since the euro zone's inception in 1999 and also since Eurostat began monitoring the countries in 1995.
But there is also division on just how far to soften the targets, and while the Commission will give Spain, France and others more time to reach its deficit goals, Berlin and the ECB want to see countries put accounts on a better footing.
Writing by Robin Emmott; Editing by Catherine Evans