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Euro zone inflation drops to lowest since 2009

A picture illustration taken with the multiple exposure function of the camera shows a one Euro coin and a map of Europe, January 9, 2013. R
A picture illustration taken with the multiple exposure function of the camera shows a one Euro coin and a map of Europe, January 9, 2013. R

By Robin Emmott and Philip Blenkinsop

BRUSSELS (Reuters) - Euro zone inflation hit its lowest level since November 2009 in March, a shock drop that raises expectations the European Central Bank will take radical action to stop the threat of deflation in the currency bloc.

Annual consumer inflation in the 18 countries sharing the euro was 0.5 percent in March, with the pace of price rises cooling from February's 0.7 percent reading, the EU's statistics office Eurostat said on Monday.

Economists polled by Reuters had predicted a 0.6 percent reading - itself worrying for an economy that is barely pulling out of a record-long recession after a crisis that nearly broke up the currency area.

The euro zone is far from the deflation that Japan suffered from the early 1990s, when falling prices weakened demand, leading to wage cuts and even lower prices, but the bloc's low inflation rate is a clear sign of economic fragility.

Inflation has now been in the ECB's "danger zone" of below 1 percent for six consecutive months, and the flash reading increases the chances the ECB will cut interest rates when its Governing Council meets on Thursday. Speculation has also grown that it may employ other easing measures such as a negative deposit rate or even U.S.-style bond-buying.

But this year's late Easter, which has delayed the impact of rising travel and hotel prices at a time when many people go away in Europe, could encourage the euro zone's central bank to wait until its June meeting to act.

"This will keep the possibility of further monetary policy easing very much alive," said Nick Kounis, head of economic research at ABN AMRO in Amsterdam. "Nevertheless, the central bank has shown quite some tolerance for low inflation recently."

The ECB, which targets inflation of just below 2 percent, left borrowing costs unchanged at 0.25 percent in March and has argued that deflation risks in the bloc are limited.

'LOW-FLATION'

Some euro zone members, like Ireland, Cyprus and Greece have experienced falling prices in recent months. For the bloc as a whole, price rises for industrial goods outside the energy sector were very modest in March, a sign demand remains weak.

On Monday, the International Monetary Fund's top European official said the ECB had more room to cut interest rates to counter risks from low inflation, although he said the Fund did not see deflation setting in.

"We are not so much worried about deflation by itself, but we are very worried about what we call 'low-flation'," said Reza Moghadam, Director of the IMF's European Department.

"There is more room for further (ECB) easing, not least because inflation is under control."

ECB President Mario Draghi suggested after the ECB's March meeting that the bank will either do nothing or take bold action should the outlook deteriorate.

He has also said the bank has been preparing additional policy steps to guard against possible deflation, and that the longer inflation remained low, the higher was the probability of deflationary risks emerging.

The relentless weakening trend may focus minds, especially

after the head of Germany's powerful central bank came out to discuss some of the bolder options in more detail, for example pumping more money into the economy via a bond-buying programme.

"There's still a case for easing, but we don't think there's going to be enough agreement within the Governing Council members to ease on Thursday," said Guillaume Menuet, an economist at Citigroup in London.

One factor that may temper the ECB's response is a sense among economists that inflation has hit bottom and will rise in the coming months. Commerzbank's Christoph Weil said he expected consumer prices to be back at 0.9 percent in April, noting the late Easter and also stabilizing food and energy prices.

(Writing by Robin Emmott; Editing by Catherine Evans)

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