July 29, 2011 / 10:46 AM / 7 years ago

UPDATE 1-Euro zone inflation falls, may help pause rate hikes

* Euro zone July inflation fall may be caused by methodology

* Slower price growth gives more time for next ECB rate rise

(Adds economists’ comments, euro reaction)

By Jan Strupczewski

BRUSSELS, July 29 (Reuters) - Euro zone year-on-year inflation slowed unexpectedly in July, the first official estimate showed on Friday, casting new doubt on whether the European Central Bank will raise interest rates again this year.

The European Union’s statistics office Eurostat estimated that consumer prices in the 17 countries using the euro grew 2.5 percent year-on-year in July, after increasing 2.7 percent in June. The Eurostat estimate does not provide monthly price growth data or any breakdown of the numbers.

Economists polled by Reuters had expected inflation of 2.7 percent in July.

“The positive inflation reading gives the ECB more room for manoeuvre given signs of a sharper than expected slowdown in economic growth and heightened risks related to sovereign debt on both sides of the Atlantic,” said Nick Kounis, economist at ABN Amro.

“Essentially, a more favorable inflation evolution could make it easier for the ECB to take a break from rate hikes if the downside risks to the outlook were to intensify,” he said.

The ECB, which raised interest rates earlier this month for the second time this year, wants to keep inflation at below, but close to 2 percent.

The lower euro zone reading came as a surprise after inflation in Germany, the euro zone’s biggest economy, hit a three-month high of 2.4 percent year-on-year this month after an unexpectedly strong upward push from oil prices.

“Eurostat’s methodology for seasonal factors has changed from January, widening the scope of the items subject to seasonal swings. This, we believe, is the main cause underlying the sharp slowdown in HICP inflation,” said Luigi Speranza, economist at BNP Paribas.

Economists had been pencilling in a third ECB rate rise this year, which would take borrowing costs to 1.75 percent from 1.5 percent now, and the German numbers reinforced that expectation.

But on Thursday a European Commission survey of economic sentiment in the euro zone in July showed optimism was weaker than expected and in a downward trend since February, which some economists said could make a ECB rate rise less certain.

“While a further interest rate hike in the fourth quarter is clearly very possible, we suspect that slowing Eurozone growth and recurrent sovereign debt problems will present an increasingly compelling case for the ECB to hold off from further monetary policy tightening this year,” said Howard Archer, economist at IHS Global Insight.

“We also anticipate that the case for further ECB action in 2011 will be diluted by mounting evidence that the second round inflationary effects from higher energy and commodity prices are being contained,” he said.

“We currently expect the ECB to keep interest rates at 1.50 percent through the rest of 2011 and lift then lift them gradually further to 2.25 percent by the end of 2012,” Archer said.

Reporting by Jan Strupczewski, editing by David Brunnstrom, Ron Askew

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