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Eurozone inflation falls to 0.5 per cent, adds pressure on central bank to act Thursday

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FRANKFURT - Inflation in the eurozone sagged more than expected to 0.5 per cent in May, increasing pressure on the European Central Bank to take action this week to support the weak economic recovery.

The figure released Tuesday by the European Union's statistics agency fell from 0.7 per cent in April and was short of market analysts' forecasts for 0.6 per cent.

Inflation has been low for several months, increasing concerns that the 18-country eurozone could fall into outright deflation, a sustained drop in prices that chokes off growth as consumers delay purchases in hopes of bargains and businesses postpone investment.

Even merely weak inflation can hold back the economy if it lasts too long. It can make it harder for indebted companies and governments to reduce debt, and it also makes it harder for weaker countries such as Greece or Portugal to become more competitive relative to their stronger trade partners such as Germany.

Tom Rogers, senior economic adviser to consultancy EY's eurozone forecasts, said Tuesday's "data underlines the fragility of the eurozone recovery, the lack of improvement in the labour market in most economies, and the persistence of the deflationary threat."

The ECB has said it's not happy with the current rate of inflation, which is well below its goal of just under 2 per cent. Analysts expect it to cut interest rates and possibly take further measures at its next meeting on Thursday.

Many expect the bank to cut its main interest rate — called the refinancing rate, at which it lends to banks — from its current record low of 0.25 per cent. The bank is also predicted to cut to negative the interest rate on money deposited with it by banks, in an effort to push them to loan that money rather than store it with the ECB.

The ECB could also take other steps to increase credit to businesses, such as by offering more cheap loans to banks that they could then lend on.

Lower interest rates should stimulate the economy by making it cheaper for companies and consumers to borrow so they can spend and invest. The ECB has cut the rate at which it lends to banks, but those cheap rates are not being passed on to companies because banks themselves have weak finances or are wary of issuing new loans.

The eurozone economy grew only a quarterly 0.2 per cent in the first three months of the year, gaining no momentum from the quarter before.

Unemployment remains painfully high and the economy has too much productive capacity that isn't being used. A separate report on Tuesday showed the jobless rate for the eurozone as a whole fell to 11.7 per cent in April from 11.8 per cent in March. The rate is much worse in countries that are still healing from the eurozone's government debt crisis, such as Spain, at 25.1 per cent, and Greece, at 26.5 per cent.

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