With euro zone inflation disappearing, ECB poised to act

By Martin Santa

BRUSSELS (Reuters) - Euro zone inflation fell unexpectedly in May, all-but sealing the case for the European Central Bank to act this week with a batch of measures to stimulate the economy and keep it from the clutches of deflation. Annual consumer inflation in the 18 countries sharing the euro fell to 0.5 percent in May from 0.7 percent in April, the EU's statistics office Eurostat said on Tuesday. Economists polled by Reuters had expected inflation to remain steady.

ECB policymakers have flagged a policy move for their meeting on Thursday and the bank's president, Mario Draghi, said last week the ECB was equipped to get inflation back to its target - just below 2 percent.

The weak May inflation reading - back at levels last seen in March, which was the lowest level since November 2009 - bolsters the case for action and will undermine any resistance hawkish members of the Governing Council might put up. "The ECB hardly needs any more reason to deliver a major package of stimulative measures at its June policy meeting on Thursday to counter the risk of prolonged very low inflation turning into deflation," said Howard Archer, chief European economist at consultancy IHS Global Insight.

Sources told Reuters last month that the ECB was preparing a package of policy options for its Thursday's meeting, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms (SMEs).

The weak May price rises cemented expectations that the ECB will now deliver a package of measures to stimulate the economy, though U.S.-style quantitative easing (QE) - or money printing to buy assets - remains some way off. "The numbers only add pressure on the ECB to spice up its easing package further this Thursday," said Jan von Gerich, strategist at Nordea.

Tuesday's reading came after a low number from Germany.

Inflation in the 9.5 trillion euro economy is stuck in the ECB's 'danger zone' of below 1 percent, a sign of the fragile recovery. The ECB says it stands ready to use all tools available to fend off deflation risks and aid the economy.

"The ECB has consistently underestimated the deflationary forces threatening Europe and now is the time for unconventional monetary policy," said Dominic Rossi, global chief investment officer at Fidelity Worldwide Investment.

MILLIONS JOBLESS

Core inflation, excluding energy, food, alcohol and tobacco, fell to 0.7 percent in May from 1.0 percent in April. Energy prices were flat on the year, showing no decline for the first time in five months.

Global financial markets have been buoyed by the odds of cheaper money in the bloc and could react sharply if the ECB does not deliver on Thursday.

The euro rebounded against the dollar after the inflation data was released, suggesting the markets have already priced in expectations of incoming monetary policy easing by the ECB.

In a sign of the slow economic recovery, a separate Eurostat data release showed the bloc's unemployment dipped marginally to 11.7 percent in April from 11.8 percent, but still near the record high of 12 percent registered a year ago.

Some 18.75 million of people are without jobs in the euro zone - 76,000 less than in March, the Eurostat data showed.

Joblessness has been stuck at almost 19 million people for the last four months and shows the human impact of the worst financial crisis in a generation, but it also varies widely across the euro zone.

The European Commission, the EU executive, said the April unemployment data was a positive sign, but there were many tough challenges ahead on the road towards a significant improvement.

"The EU finally has to turn a vicious circle into a virtuous one, where more people can work, earn, spend and thereby create demand for other people's work too," Laszlo Andor, the EU's commissioner for employment said in a statement.

"By shifting taxation away from low-paid labour, hiring can be made easier and household incomes can be boosted," he added.

(Additional reporting by Robin Emmott Editing by Jeremy Gaunt)