Euro Zone in Recession, Boosting Case for Rate Cut

The euro zone economy fell into its first technical recession in the third quarter, boosting expectations that the European Central Bank would cut interest rates in December.

The economy of the 15 countries using the euro shrank 0.2 percent in July-September, as it did in April-June -- with the two consecutive quarters of contraction satisfying the technical definition of recession.

"Unfortunately, it is only the beginning," said Gilles Moec, economist at Bank of America. "We can expect further quarters of negative GDP growth, until the third quarter of 2009, simply because so far we have not had in the GDP figures the full impact of the credit market crisis."

Economic output grew by 0.7 percent in the third quarter from a year earlier -- half the rate in the second quarter, according to the data, which was in line with expectations of economists polled by Reuters.

The euro zone performance was weaker than that of the United States, where output fell 0.1 percent on the quarter and grew by 0.8 percent in annual terms.

"We do not expect renewed growth of the euro zone economy until the second half of 2009, when European Central Bank rate cuts will gradually start to have a visible positive effect," said Christoph Weil, economist at Commerzbank.

The ECB has cut interest rates by a total of one percentage point since early October, to 3.25 percent, to boost financial market confidence as inflationary pressures wane along with the sharp slowdown in economic activity.

"The ECB will probably cut the key interest rate to 1.75 percent by next spring," Weil said.

The ECB wants to keep inflation below, but close to 2 percent over the medium term.

It was thrown off track by a sharp rise in oil and food prices in the 12 months to July, but oil prices have since dropped to a third of their July peak.

Eurostat said euro zone consumer prices were unchanged in October compared with the previous month and confirmed its earlier estimate that the annual rate of inflation slowed to 3.2 percent from September's 3.6 percent.

The main reason for the deceleration in inflation was a 2.9 percent monthly drop in energy costs.

A measure of inflation that excludes volatile energy and unprocessed food components rose 0.4 percent on the month to give a 2.4 percent annual rise.

The annual rate was down from 2.5 percent in September and 2.6 percent in August.

This lower reading for what the ECB calls core inflation is seen as an indication of an easing in the risk of second-round inflation effects, where oil price rises boost prices in other sectors and wage growth demands.

"We expect the ECB take interest rates down to 2 percent by the middle of next year, with the next move likely to be a 50 basis point reduction in December," said Nick Kounis, economist at Fortis.

The second quarterly GDP decline in the euro zone was prompted mainly by a technical recession in the biggest economy, Germany, and the third-biggest, Italy.

The second-biggest, France, defied market expectations of a similar fate, growing by 0.1 percent in the third quarter.

The fourth-biggest economy, Spain, also contracted in the July-September period by 0.2 percent and the European Commission expects the country will be in recession after expected negative growth in the fourth quarter.

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