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Euro zone inflation to offer clues on ECB action

A picture illustration taken with the multiple exposure function of the camera shows a one Euro coin and a map of Europe, January 9, 2013. R
A picture illustration taken with the multiple exposure function of the camera shows a one Euro coin and a map of Europe, January 9, 2013. R

By Philip Blenkinsop

BRUSSELS (Reuters) - Euro zone inflation due on Friday will be firmly in the sights of financial markets eager to establish whether the European Central Bank (ECB) has enough ammunition to ease monetary policy in the following week.

Inflation in the 18-member euro zone unexpectedly slowed to 0.7 percent year-on-year in January, matching a four-year low set last October and confounding expectations for a rise to 0.9 percent.

The ECB cut its main refinancing rate to a record low of 0.25 percent in November and left it at that level at its meeting earlier this month, but put markets on alert for a possible move in March.

ECB President Mario Draghi said the Governing Council had not acted because of the complexity of the situation and the need to have more information.

The next meeting on March 6 will have new forecasts from the bank's staff extending into 2016.

Friday's February inflation figure could cause a fine-tuning of those forecasts, which form the basis of the ECB's monetary policy.

"The big issue is whether they are comfortable with their medium-term trajectory. That's obviously something that's going to get revised down a bit ... Next week's reading will in some sense influence their thinking," said David Mackie, chief European economist at JP Morgan.

Further country data could mean the January figure being revised up to 0.8 percent on Monday, but the consensus view is for a 0.7 percent reading for February.

CLOSE CALL

Commerzbank, which predicted the 0.7 percent figure in January, sees a further drop to 0.6 percent for February. Christoph Weil, economist at the bank, said this would prompt the ECB to reduce its 2014 and 2015 inflation forecasts each by 0.2 percentage points from already low levels of 1.1 and 1.3 percent respectively.

"It's a close call, but we see the ECB cutting interest rates," Weil said, adding Commerzbank's view is that the main repo rate would drop to a fresh low of 0.1 percent.

The market consensus is for no further cut.

Inflation data will arrive at the same time as unemployment figures. The typically lagging indicator is expected to show no improvement in January from the 12.0 percent rate of December.

Across the Atlantic, the debate rages on about whether the U.S. economy's apparent weakness at the start of this year is purely a temporary blip caused by an exceptionally cold winter or something longer-lasting.

Federal Reserve Chair Janet Yellen will testify before the Senate Banking Committee on Thursday, some two weeks after she told the House Financial Service Committee that the central bank would keep on reducing its stimulus.

Lawmakers may ask whether she has a different view on the weather question, although few expect an abrupt change.

After a week featuring a promising survey of U.S. manufacturers, but a decline of housing starts, factory activity and home sales, there will be more data on home prices and sales, consumer confidence and durable goods orders.

For Nomura's chief U.S. economist Lewis Alexander, the latter, due on Thursday, is particularly important given that higher fixed investment by businesses underpins many economists' outlook of a better rest of the year.

Alexander said some weakness in the first quarter had been expected, even without the harsh weather, because of a strong second half of 2013 supported by inventory accumulation.

SOMETHING BIGGER

The jury would be out until a spring thaw on whether the weakness went beyond the weather and the inventories issue.

"If you look at the breadth of the weakness we've seen in the last six weeks or so, in things like the retail sales report and the weakness on payrolls, I think it certainly is consistent with the notion that there's something bigger going on than just those two temporary factors," he said.

The weather of course will influence the durable goods data, such as in terms of capital goods for the construction sector.

In China meanwhile, the economy really is weakening.

Activity in China's factories shrank again in February, a survey showed, the minor slowdown in the world's second-largest economy enough to upset markets across the region.

The flash Markit/HSBC Purchasing Managers' Index (PMI), released last week, dropped to a seven-month low of 48.3 in February, the second month at a level below 50, indicating contraction.

Official PMI from the National Bureau of Statistics, with a bigger sample size, will provide a further guide on Saturday and could add to the view of some economists, still in the minority, who believe China will need to ease policy to support growth of 7.5 percent.

In Japan, data due on Thursday are expected to show factory activity accelerated in January, after disappointing fourth-quarter growth figures cast doubt on the effectiveness of the aggressive stimulus of Prime Minister Shinzo Abe's year-old government.

Thursday is also likely to see Japan's core inflation hovering at five-year highs above 1 percent, but still well below the Bank of Japan's (BoJ) 2 percent goal.

A Reuters poll last week showed the BoJ is expected to ease monetary policy further by the summer to help boost the economy as the effects of the government's stimulus begins to wane.

(Additional reporting by Jason Lange in Washington, Gui Qing Koh in Beijing and Tetsushi Kajimoto in Tokyo; Editing by David Holmes)

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