Inflation slows as figures in Euro zone highlight two-speed recovery

European Union statistics office Eurostat reported that inflation in the 16-nation currency area fell to 1.6 per cent year-on-year in August from 1.7 per cent in July, in line with economists' expectations and comfortably below the European Central Bank's target of just under 2 per cent.

No breakdown of the inflation figure is available until later this month, but economists said the easing was most likely a result of cheaper energy and lower core inflation, which excludes the more volatile energy and food prices.

"Inflation will not be an issue for a period of one to two years," said Christoph Weil, economist at Commerzbank.

He said wages, which largely determine inflation, would rise only moderately in 2010 and 2011 because high unemployment and resulting fears of losing jobs will enforce wage constraint.

Eurostat said unemployment in the euro zone was unchanged at 10 per cent of the workforce for the fifth month running – a factor economists said was undermining household de-mand.

Inflation is also likely to be curbed by the still low utilisation of production capacity and by fiscal tightening, as governments try to shore up public finances in the wake of the recession to win back market confidence in their policies.

"In 2011, we forecast an inflation rate of 1.7 per cent, after an expected 1.4 per cent this year. The favourable inflation outlook gives the ECB the scope to leave rates at their very low level for the time being.

"We do not expect the first rate hike before the end of 2011," Mr Weil said.

The ECB meets on interest rates tomorrow and economists expect it will keep them at the historic low of 1.0 per cent.

Economists said the persistently flat euro zone unemployment rate of 10 per cent, near a 12-year high despite strong growth in the second quarter, masked diverging trends in the single currency area.

While unemployment in Europe's powerhouse Germany has been on the decline for 14 months in a row, and fell to 7.6 per cent in August, the opposite trend can be seen in Spain and Ireland – where it rose to 20.3 and 13.6 per cent in July respectively.

"We have the periphery countries where the labour market is showing no improvement and we have the core euro zone where the labour market is actually pretty good and continues to show good news," said Carsten Brzeski, economist at ING.