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Deflation fears return as euro zone inflation slips

Euro zone consumer inflation came in lower than expected in December, adding to concerns that the euro zone could be heading towards a period of deflation.

Consumer prices rose by 0.8 percent year-on-year in December, below the 0.9 percent expected by economists. It comes after inflation increased by 0.9 percent in November.

David Gould | Photographer's Choice RF | Getty Images

The data is unlikely to allay deflationary concerns which were ignited when October's figures showed the rate of inflation had fallen to a 47-month low of 0.7 percent.

(Read more: Euro zone economic recovery gathers steam)

The figures for the 18-country currency bloc are closely watched by the European Central Bank (ECB), which cut its main interest rate to 0.25 percent from 0.5 percent following October's surprisingly-low inflation data.

The euro hit a session high on the news on Tuesday. It rose to $1.3647 from $.13614 on anticipation that the central bank might do more to support the economy.

The bank's Governing Council will announce its latest policy decision on Thursday, and although it is not expected to deploy any of its "powerful artillery" this month, the most recent inflation figures could lead to calls for more stimulus in 2014.

Inflation remains well below the bank's 2 percent target, leaving the door open for more monetary easing by ECB President Mario Draghi in the short-term.

Ishaq Siddiqi, market strategist at ETX Capital, said the data meant "deflation fears are back on board."

"Draghi and Co are likely to face more pressure to act with stimulus measures to tackle deflation," he said in a note. "If inflation keeps edging lower, the likelihood of another cut to the refi rate or even negative deposit rates seem to be more pronounced than before."

(Read more: ECB unlikely to deploy its artillery, but pressure grows)

The data come amid growing signs that the economic recovery in the euro zone is gathering pace. On Monday, data revealed that services and manufacturing activity in the region expanded in December. The Markit composite purchasing managers' index (PMI) data showed that activity in the sectors rose to 52.1 in December, up from 51.7 in the previous month.

But economists were quick to point out that although the region as a whole appeared to be doing well, growth was uneven on a regional level.

Germany, Ireland and Spain's PMIs, for example, all came in well above the 50-point mark indicates expansion. But France's negative trend accelerated in December, with services and manufacturing activity hitting a 7-month low.

(Read more: Euro zone manufacturing grows; France stumbles on)

Howard Archer, chief European economist at IHS Global Insight, said that although these economic surveys had eased some of the pressure on the ECB, Tuesday's inflation figures meant the bank was "more likely than not" to take further action eventually.

"The renewed dip in euro zone consumer price inflation to just 0.8 percent in December is particularly unwelcome news for the ECB as it takes inflation almost back down to the level where the bank felt compelled to cut interest rates," he said in a note.

"While the ECB remains adamant that deflation across the euro zone is not a serious risk, it will undoubtedly be uncomfortable with this latest dip in consumer price inflation which is over a percentage point below its target rate."

By CNBC's Katrina Bishop. Follow her on Twitter @KatrinaBishop and Google

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