European Inflation Rate Declines Most Since 1991

Europe’s inflation rate fell the most in almost two decades last month as oil prices plunged, giving the European Central Bank more leeway to cut interest rates.

The inflation rate in the euro area declined to 2.1 percent from 3.2 percent in October, the biggest drop since at least 1991, the European Union statistics office in Luxembourg said today. That matched the initial estimate published Nov. 28.

ECB President Jean-Claude Trichet said yesterday there’s a limit to how far the bank can cut interest rates even as economic growth slumps and inflation cools. By comparison, the U.S. Federal Reserve yesterday cut its main rate to “a target range” of between zero and 0.25 percent and said it will use “all available tools” to battle the recession. The ECB has reduced the rate by 175 basis points to 2.5 percent since early October.

“For the ECB, the outlook is rather grim and they should act further as we have seen a strong deceleration in inflation rates,” Alexander Koch, an economist UniCredit MIB in Munich said on Bloomberg Television. “There is no need to wait. The situation requires tough action.”

‘Harsh Reality’

The dollar dropped to $1.4192 per euro today, the weakest in 11 weeks, after the Fed cut. The British pound also weakened, falling to a record low of 91.33 pence per euro after data showed U.K. unemployment rose in November at the fastest since 1991.

Trichet yesterday signaled the ECB may pause in January after making a record cut of 75 basis points this month. ECB council member Axel Weber has said he “would like to avoid” taking the rate below 2 percent.

“The Fed is going all out,” said Marco Annunziata, chief economist at UniCredit in London. “I still believe the harsh macro reality will eventually force the ECB’s hand.”

Euro area consumer prices fell 0.5 percent in November from the previous month, according to today’s report, with transport fuels knocking 0.41 percentage points off the monthly index.

The rate of annual energy-price inflation plunged to 0.7 percent from 9.6 percent and food-price inflation also eased. The core rate of inflation, which excludes food and energy prices, remained at 1.9 percent in November.

Inflation peaked at 4 percent in July after oil prices surged to a record $147 a barrel. Crude has since dropped by more than two-thirds to around $45 a barrel.

The drop in commodity prices and a deteriorating economic outlook has raised concern about the emergence of deflation. The ECB has discounted the threat, saying it sees disinflation, a slowing of price increases, rather than deflation, a period of sustained price declines.

“It looks odds-on that euro-zone consumer price inflation will fall well below 1 percent during 2009, and a brief period of deflation certainly cannot be ruled out,” said Howard Archer, chief European economist at IHS Global Insight in London.

Deflation is also emerging as a risk in the U.S., where consumer prices fell the most on record in November. In the U.K., the inflation rate fell to 4.1 percent in November from 4.5 percent the previous month, according to data yesterday, and Bank of England Governor Mervyn King has signaled that the bank will cut the interest rate further if needed.