BERLIN German inflation slowed in January as retailers cut prices after Christmas and the euro strengthened, opening up more space for a possible future policy shift at the European Central Bank.
Statistics Office data on Thursday showed inflation eased to 1.7 percent on the year in January, falling back below the ECB's target of just under 2 percent for the euro zone as a whole.
Annual inflation now stands at its lowest level since July last year despite an increase in energy prices. Thursday's reading was below a Reuters poll forecast for an acceleration to 2.0 percent and compared with a 2.1 percent annual increase in the cost of living in December.
The office said increases in the cost of living slowed after the German government decided to scrap from January 1 a fee of 10 euros paid to doctors and dentists for the first visit in every quarter.
Some analysts said a stronger euro had contributed to the easing in price pressures.
"It seems pretty clear to me that the exchange rate or the euro appreciation has had an impact on German inflation via import prices, and of course the ECB could try and do something about that," said Christian Schulz at Berenberg Bank.
"If Germany has been impacted by lower import price inflation it's likely that the euro zone data which we get tomorrow is also impacted by that, which poses a downside risk to the ECB's inflation risk and the ECB may next week try and sound a little more dovish."
The euro has gained broadly this month as easing euro zone debt worries have prompted investors to reinvest in the region after shunning it for much of last year due to concerns the bloc might break up.
Germany's inflation rate held above 2 percent for much of 2012 as its economy steamed ahead of its peers in the single currency area and workers secured high pay rises, with the giant IG Metall union clinching its highest raise in 20 years.
That posed a dilemma for the ECB, which struggled to balance monetary policy for Europe's economic powerhouse with the needs of struggling states such as Greece, Italy and Spain.
The ECB left interest rates at a record low of 0.75 percent in January and is expected to do so again in February.
"I don't see that this drop in inflation would encourage the ECB to lower rates again but if this trend were to continue then it might open up the door for a rate cut again," said Carsten Brzeski, senior economist at ING Bank.
Brzeski attributed Thursday's lower figure mainly to seasonal discounts on holidays and items such as clothing, as well as the scrapping of the doctors' fee.
Even Germany took a battering from the euro zone storm in the fourth quarter, contracting by 0.5 percent according to a preliminary estimate. However, most economists see it escaping a recession, defined as two consecutive quarters of contraction.
Recent data has shown exports, imports, orders and retail sales sliding and the manufacturing sector shrinking, although unemployment has fallen and sentiment surveys have taken a turn for the better.
The wages of some 12.5 million workers are up for negotiation this year and economists reckon their paychecks will outpace prices to rise between 2.5 and 4.0 percent, which some economists worry could push inflation higher.
The government and the country's central bank have both hinted they would tolerate higher prices as long as euro-wide inflation remains under control. That could help weaker euro zone countries boost their competitiveness.
On a monthly basis German prices fell by 0.5 percent, after accelerating by 0.9 percent in December. The month-on-month figure was driven down by cheaper package holidays compared with December, when expensive Christmas and New Year getaways helped push inflation higher, the statistics office said.
The month-on-month fall was below a Reuters consensus forecast for a 0.4 percent dip in prices.
Consumer prices harmonized to compare with other European Union countries showed a monthly drop of 0.7 percent and an annual rise of 1.9 percent.
The Statistics Office's preliminary inflation calculations are based on data contributed by six German states. Data for the states has not yet been released as the consumer inflation index, which currently uses 2005 as its base year, is being updated with 2010 as its new base.
Final German price data for January are due to be released on February 20, the Office said.
(Reporting by Michelle Martin; Editing by Catherine Evans)