Eurozone inflation tumbles

BRUSSELS, Belgium (Reuters) -- Euro zone inflation sank below the European Central Bank's ceiling to two-and-a-half year lows in June, according to data on Friday, which should allow the ECB to keep interest rates unchanged without any qualms.

Less than a week before the ECB's July 4 policy meeting, the European Union statistics office estimated that consumer prices rose by 1.7 percent in June compared with a year earlier, slower than the 1.9 percent rate expected by economists.

It was not only the first time since May 2000 that inflation had fallen below the ECB's two percent ceiling but also its lowest since December 1999 -- more than enough to elicit a rally in European government bond futures and cheers from officials.

"The number is quite a bit better than the bond market had expected,'' said Nick Mirtchev at HBOS Treasury in London.

"Inflation is now considerably below the ECB's target and taking into account the mixed to weak economic activity we've seen recently, it is unlikely we will get a rate hike before the fourth quarter.''

The bond markets were not the only ones to take heart from signs of abating price pressures. The Commission, the EU executive, welcomed the latest data and said it hoped for more benign inflation reports in the coming months.

"That is good news and we look forward to confirmation and subsequent good figures in the future,'' Commission spokesman Jonathan Faull told a press briefing. He declined to comment on the implications for euro zone interest rates.

The decline in the euro zone inflation rate had been flagged by previously released national consumer price reports.

The latest had come from Italy, which said earlier on Friday that its inflation slowed to a 30-month low of 2.2 percent in June from May's 2.3 percent.

That followed on the heels of the subdued consumer price report released earlier this week by Germany, Europe's largest economy, where inflation is running at 0.9 percent, its slowest pace since November 1999.

One of the euro zone's smaller economies, Belgium, had also reported a sub-one percent inflation rate, with its consumer prices rising at an annual rate of 0.88 percent in June compared with the 1.33 percent clip seen in May.

Economists have warned that inflation may edge higher in the coming months because of statistical effects from last year.

The ECB's own staff are forecasting euro zone inflation will average between 2.1 percent and 2.5 percent in 2002 and also ECB officials have expressed concern about the pace of price rises in the service sector.

Financial markets are therefore still expecting a rate increase later this year, with 30 out of the 57 analysts polled by Reuters before the release of the latest inflation data

expecting the hike to be delivered in September.

Still, there are other factors which are expected to help the ECB in its fight against inflation.

The recent rise in the euro's value on the foreign exchanges is expected by economists to bear down on inflation by making imported goods less expensive in single currency terms.

Professor Bert Ruerup, one of five "wise men'' who advise the German government and produce an annual economic report used to shape official growth forecasts, stressed the positive aspects of a stronger euro.

"Imports become cheaper. Inflation worries decrease, allowing the European Central Bank to keep interest rates lower,'' Ruerup told Reuters.

The euro has risen about 12 percent so far this year against the dollar, and is trading about a quarter cent short of dollar parity as it scales its highest since February 2000.

Moreover, there are few signs of pipeline price pressures.

A report out of France on Friday showed producer prices in the euro zone's second largest economy fell by a larger-than-expected 0.3 percent in May compared with the

previous month and were down 1.5 percent from a year earlier.

"The current recovery is going ahead without any price pressure. The European Central Bank has therefore no reason to fear inflation,'' said Marc Touati, economist at Natexis Banque Populaire.