Euro slides as inflation falls to two-year low

Inflation in the eurozone has fallen to a two-year low, it was announced yesterday, news that pushed the euro sharply lower against the US dollar and the pound as expectations of sharply lower European interest rates rose.

During trading, the single currency dropped as much as 2 per cent against the dollar, to around $1.33, its weakest level in three weeks. The euro fell to 91 pence, compared to the near parity achieved at the end of the year. The eurozone, and in particular Germany, has been hit by the relatively high value of the single currency, which has hampered exports.

The official Eurostat agency said yesterday that the annual rate of inflation in the 15 countries using the euro in December was 1.6 per cent, down from 2.1 per cent in November and well below the ECB's target of below but near 2 per cent. (Slovakia became the 16th member on 1 January).

Having led the Bank of England for some months, the ECB has now set rates higher than the Bank, the US Federal Reserve and the Bank of Japan. Howard Archer, the chief UK and European economist at Global Insight, commented: "Sharply contracting new orders, backlogs of work and employment reinforce belief that the eurozone faces an extremely difficult start to 2009.

"The surveys of business confidence add to the evidence that underlying eurozone inflationary pressures are now retreating sharply. Consequently, pressure is mounting on the European Central Bank to relax policy and we expect it to cut its key interest rate by 50 basis points to 2 per cent".

The ECB has already cut rates from 4.25 per cent to 2.5 per cent since October, as inflation has subsided from its July peak of 4 per cent.

The state of the eurozone economy is also pushing the continent's biggest economy, Germany, towards the type of fiscal stimulus previously dismissed by some of its leading figures as "crass". A new €50bn (£45.4bn) fiscal package, amounting to about 1 per cent of GDP over two years, is under discussion by the coalition partners, and goes beyond earlier more modest measures. This would bring Germany closer into line with the rest of the G7.