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Easing Inflation, Wages Aid Case for Euro Zone Simulus

Peter Weber | Getty Images

Inflation pressures in the euro zone are easing, data showed on Friday, giving governments and central bankers a touch more leeway for stimulus as the region's leaders seek to shift their focus to reviving economic growth.

Modest wage growth and a cooling of food price pressures drove annual euro zone inflation down to 1.8 percent in February, its lowest level since mid-2010, the EU's statistics office said on Friday.

The figure, which confirmed Eurostat's flash estimate from March 1 and was as expected by economists polled by Reuters, is around the European Central Bank's target of below but close to 2 percent.

Combined with only very modest wage increases in the fourth quarter of 2012, the data highlights the weakness of the euro zone economy and will fuel expectations in some quarters that the ECB could cut interest rates this year.

(Read More: Euro Zone Sentiment Falls Sharply in March)

"With inflation set to undershoot the ECB's objective, an interest rate cut appears to be largely constrained by the prospect of an economic recovery in the second half of this year," Citigroup said in a research note on Friday.

But with commercial bank lending in the euro zone still subdued despite base rates being at a record low of 0.75 percent, others are skeptical about the impact of another cut.

Three quarters of economists expect the ECB to leave rates unchanged for the rest of the year, according to a Reuters poll published on Wednesday.

Already in recession in 2012, the euro zone economy is expected to shrink 0.3 percent this year as households and businesses struggle with the fallout of the bloc's public debt crisis and government spending cuts.

(Read More: EU Offers Crisis-Hit Members Wiggle Room on Deficits)

Thousands of protesters called on EU leaders, whose two-day summit in Brussels is due to end on Friday, to put an end to the austerity blamed for record unemployment in parts of Europe.

"Market pressure on European governments has been replaced by people pressure as a result of austerity and reform fatigue," said Barclays economist Philippe Gudin.

Growth and Austerity

The ECB's role is important because EU leaders are trying to find ways of reviving economic growth while budget discipline remains part of their strategy to overcome the bloc's debt crisis.

"There are no easy answers," European Council President Herman Van Rompuy, who chairs the summit, told a news conference on Thursday night. "The good progress towards structurally balanced budgets must continue," he said.

France and Italy did win support for a slightly more growth-friendly interpretation of European Union budget rules at the summit after French President Francois Hollande challenged German-driven fiscal austerity.

(Read More: Germany Defies Calls for Stimulus)

One silver lining in the Mediterranean region is that only very modest wage increases are helping to improve competitiveness after a decade-long boom fueled by easy credit pushed the euro zone into a false sense of economic wellbeing.

Hourly labor costs in the euro zone rose 1.3 percent overall in the last three months of 2012, compared to the same period in 2011. Wages per hour grew by 1.4 percent.

Those rises were less than half the level of increases in early 2009, at a time when Europeans were giving themselves generous pay hikes, pushing up the cost of labor by 12 percent between 2001 and 2011.

In Spain, hourly labor costs fell 3.4 percent, but Germany recorded a 2.9 percent increase, which bodes well because wealthier consumers in Europe's largest economy could buy more of their neighbors' products.

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