Euro zone inflation hit an all-time high in January and economic sentiment plunged to two-year lows, data showed, raising the spectre of stagflation and deepening the European Central Bank's policy dilemma.
"Euro zone economic data has stagflation written all over it right now," said Bear Stearns European Economist David Brown.
The European Union's statistics office estimated that inflation in the 15 countries using the euro rose to 3.2 per cent year-on-year in January, the highest reading since measurements for the single currency area began in January 1997.
Economists had expected inflation to remain at 3.1 per cent, as in December and November.
No monthly data or detailed breakdown was available with the Eurostat estimate, but economists said the consumer price index was most likely again boosted by food and oil prices.
This was confirmed by Spanish data earlier on Thursday, which showed prices rose at their fastest rate on record in January due to higher food and utility bills. Belgian inflation was driven to 16 year highs by the same factors.
While economists expect inflation to slow down later this year, some said it could get worse before it gets better.
"Inflation could edge higher in the coming months, peaking at 3.3 per cent in February/March," said Sunil Kapadia, European economist at UBS.
The ECB wants to keep inflation just below 2 per cent over the medium-term, but has refrained from raising rates from the current 4 per cent because of signs that the economy is slowing.
With inflation at a record high it is equally difficult for the bank to cut rates, though economists noted that in May 2001, when inflation was at 3.1 per cent and consumer inflation expectations higher than now, the ECB did cut rates.
Inflation expectations among businesses, measured by a European Commission's monthly survey, showed a slight increase to 14 points from 13 in December. But inflation expectations among consumers were stable for the third month in a row at 28 -- lower than the 33 points when rates were cut in May 2001.
Most economists believe therefore that the bank will have to cut rates later this year, following the example of the US Federal Reserve, to support euro zone expansion.
Euro zone inflation hits new high