Eurozone inflation slumps to 2-year low of 1.6 pct

(BRUSSELS) - Inflation in the euro countries slumped in December to the lowest level in over two years, according to an official EU estimate on Tuesday and clearing the way for more interest rate cuts.

The European Union's Eurostat data agency estimated that 12-month inflation in the eurozone fell to 1.6 percent in December from 2.1 percent in November, dropping to the lowest level since October 2006.

The European Central Bank strives to keep annual inflation close to but less than 2.0 percent, but the rate had not been below that level since August 2007 amid an oil and commodities prices boom, which has recently deflated.

"December's sharp drop in eurozone CPI inflation ... supports our view that ECB interest rates will fall to almost zero, if not all the way, this year," said Ben May at consultants Capital Economics.

The euro sank against the dollar in the wake of the data, falling to 1.3406 dollars as tumbling eurozone inflation raised expectations the ECB would slash interest rates again next week.

ECB vice president Lucas Papademos said in an interview published on Monday that he saw further room for interest rate cuts if inflation remained low.

"If, in our assessment, the risks to price stability change further in the coming months, monetary policy could be eased further and we will act appropriately," he told German magazine WirtschaftsWoche.

The slump in inflation comes amid growing signs of a deep recession in the eurozone, with a survey showing on Tuesday that service sector activity retreated at the fastest pace on record in December.

After hitting a record high of 4.0 percent in June and July, eurozone inflation has fallen sharply as oil and other commodity prices collapsed in the face of a deep economic downturn.

The drop in inflation has paved the way for a series of interest rate cuts by the ECB, which slashed its main rate last month by a record three quarters of a percentage point to 2.50 percent.

"It looks odds-on that eurozone consumer price inflation will fall well below 1.0 percent during 2009, and a brief period of deflation certainly cannot be ruled out," said IHS Global Insight economist Howard Archer.

The eurozone counts 16 members since Slovakia adopted the currency at the beginning of the month.