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Euro zone morale hits record low, boosts rate cut case

Euro zone economic sentiment hit record lows in January and inflation expectations fell, data showed, boosting the case for more European Central Bank interest rate cuts as the economy sinks deeper into recession.

Economic sentiment in the 16 countries using the euro dropped to 68.9 points - the lowest since records began in 1985 - from an upwardly revised 70.4 in December, the European Commission said on Thursday.

Before the revision, economists polled by Reuters had expected a fall to 65.8.

“Record low euro zone business and consumer confidence in January, a marked slowing in loans to the private sector and further clear evidence of dwindling inflationary pressures, reinforce the already strong case for another ECB interest rate cut,” said Howard Archer, economist at IHS Global Insight.

The ECB meets on interest rates next Thursday. The bank's president, Jean-Claude Trichet, has signaled markets should not expect another cut then, but that the next important rate-setting meeting would be on March 5.

Economists said what was a relatively small decline in January economic sentiment would play well with the bank's apparent intention to pause with cuts in February.

“Tentative signs of stabilization in the pace of recession should be enough to keep the ECB on hold next week, but the need for further rate cuts is clear, in our view,” said Aurelio Maccario, chief euro zone economist at Unicredit.

The ECB wants to keep inflation expectations anchored at its target of below but close to 2% over the medium term.

But the monthly Commission survey showed that inflation expectations among households fell again, to 5 points from 7 in December, close to an all-time low of 3 from April 2004. Among firms, inflation expectations set a record low of -11.

“While the ECB has hinted strongly that it will pause in cutting interest rates in February ... we expect another 50 basis points reduction to 1.50% in March,” Archer said.

The bank has cut interest rates by 225 basis points to 2% since October as falling oil prices halved the rate of inflation in the same period and data pointed to an annual contraction of the economy of almost 2%.

The euro zone economy is sinking deeper into its first recession because of the global credit crunch, which has slashed financing to companies and households, curbing demand and causing corporate belt-tightening.

The EU statistics office, Eurostat, is due to release an initial estimate of euro zone January inflation on Friday. Analysts polled by Reuters expect a drop to 1.4% year-on-year from December's 1.6%.

The Commission survey showed the deterioration of optimism was strongest in the services sector, which generates more than two thirds of the euro zone's gross domestic product. It set a record low of -22, from -17 in December.

Sentiment in industry hit a new low of -34 against -33 in December, and optimism among consumers declined to a record low of -31 from -30.

Sentiment among consumers in the euro zone's biggest economy, Germany, fell sharply in January to -27 from -22, just one point above an all-time low of -28 from October 1993. German unemployment rose in January by 56,000 -- the highest increase in nearly four years.

The Commission's business climate index, which points to the phase of the business cycle, eased to -3.16 points in January from an upwardly revised -3.09 in December, marking the lowest since records started in January 1985.

“The indicator suggests that annual industrial production growth will be clearly negative in January 2009,” the Commission said in a statement.

“The drop in the BCI reflects a general deterioration in its underlying components; however, the downward development in the components was less dramatic than in the past three months,” the Commission said. (Reuters)