European inflation drops to lowest in 2 years

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: Europe's inflation rate fell to the lowest in more than two years in December as oil prices plunged and consumer spending slumped, increasing the scope for the European Central Bank to reduce borrowing costs further. Consumer-price inflation in the euro area slowed to 1.6% from 2.1% in November, moving below the ECB's 2% ceiling for the first time since August 2007, the European Union statistics office in Luxembourg said on Tuesday. A separate report showed the region's services industry contracted for a seventh month.

As the global financial crisis damps economic growth, slowing inflation may prompt the ECB to extend a series of interest-rate cuts that already has seen its key rate fall by 1.75 percentage points since early October. The euro extended declines after the inflation report, falling to a three-week low.

The figures “further weaken the hands of the hawks on the ECB governing council and increase the prospect of the ECB cutting interest rates next week,” said Martin van Vliet, an economist at ING Groep NV in Amsterdam. “Looking ahead, inflation is set to slip further below the ECB's target.”

Economists expected inflation to ease to 1.8% in December, according to the median of 28 forecasts in a Bloomberg survey. The euro, which fell to as low as $1.3349 on Tuesday, was down 2% to $1.3365 at 11:18 a.m. in London. The ECB last month predicted the euro-area economy will shrink about 0.5 % this year, which would be the first annual drop in gross domestic product since the euro's introduction a decade ago.

Retail sales fell for a seventh month in December, manufacturing shrank at a record pace and lending to the private sector stagnated, reports in the past month showed. Carrefour SA, Europe's largest retailer, said on December 17 it plans an “aggressive” discounting campaign to protect its market share as consumers scale back on spending.

As global growth slows and energy costs decline amid slackening demand, concerns about deflation are increasing. The price of crude oil has fallen by two-thirds since reaching a record $147.27 a barrel in July.

ECB policymakers, who aim to keep the inflation rate just below 2%, have indicated that the chances the central bank's governing council will lower borrowing costs when it meets next week are increasing as data show the economy falling deeper into a recession.