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Euro zone sentiment at record low, deep ECB cut seen

Euro zone economic sentiment set record lows in December amid rising unemployment, data showed, and inflation expectations tumbled, further strengthening the case for a deep European Central Bank rate cut next week.

The European Commission said economic sentiment in the 15 countries using the euro in December plunged to 67.1 points - the lowest since records began in 1990 - from 74.9 in November.

The grim data is likely to reinforce expectations of a deep ECB interest rate cut on Jan. 15, especially as Commission data showed that inflation expectations among households tumbled to 7 points from 11 in November and among firms to -7 from 0.

The ECB wants to keep inflation just below 2% but some members of its rate-setting council expressed concern that price growth could be slowing too much after inflation fell to 1.6% in December from 2.1% in November.

ECB Governing Council Member Vitor Constancio and Vice- President Lucas Papademos have said the bank may cut rates so as not to allow inflation to fall too low, concerned about the threat of deflation.

Markets have fully priced in a 50 basis point rate cut next week to 2%, but some economists said the ECB may settle for less after remarks from ECB President Jean-CLaude Trichet that the bank's previous rate cuts had yet to take effect.

“Clearly, after today's figures chances for a 50 basis point move are rising,” said Aurelio Maccario, chief euro zone economist at UniCredit.

“Considering that Trichet himself has been claiming that a pause would have been wise in order to see how recent cuts feed through the real economy, we ... think that the consensus within the council will coagulate on a 25 bp move,” he said.

“However, a 50 bp cut won't surprise us at all, actually that's what the economy needs right now,” Maccario said.

The Commission's business climate index, which points to the phase of the business cycle, tumbled to -3.17 points - the lowest since records started in 1985 - from -2.10 in November.

Economists said the sentiment data pointed to a contraction in GDP of 0.7-0.8% in the fourth quarter, and more later.

“The euro zone economy will probably contract more in the first half of 2009. For 2009, we expect real GDP to decline by 2%-3%,” said Christoph Weil, economist at Commerzbank.

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 European Union statistics office said euro zone unemployment rose to 7.8% in November from 7.7 in October and confirmed third-quarter gross domestic product shrank 0.2% quarter-on-quarter, the same as in April-June.

Unemployment expectations among households surged to 55 points from 44 in November, coming close to an all-time high of 60 set in 1993, the Commission survey showed.

Economists said rising fears of unemployment were weighing on consumers' spending plans despite lower oil prices. This, in turn, boded ill for company investment and hiring plans.

The Commission survey showed consumer plans for major purchases over the next 12 months remained at an all-time low for the third month running in December.

“The situation on the labor market will deteriorate drastically in the months ahead. This means lower income for private households, weaker consumption and further job cuts,” said Commerzbank's Weil. (Reuters)