Euro zone slowdown gathers pace as does inflation

By Ross Finley

LONDON (Reuters) - Euro zone economies are slowing, and at very different speeds, but inflation remains consistently high, according to data that makes the European Central Bank's job of setting interest rates even tougher.

Key private sector surveys of its biggest economies this week point to weakening growth in the euro zone as a whole, with France and Germany still growing modestly, Italy stagnating and Spain in freefall.

RBS/NTC said their euro zone services index fell to 51.6 in March from 52.3 in February and was revised down slightly from the flash estimate of 51.7, where 50.0 is the line that divides expansion and contraction. The composite index that combines manufacturing and services also slipped to 51.8.

At the same time, the surveys conducted by NTC Economics underscore evidence from official government data that show inflation pressures, for the moment at least, are intensifying because of higher food and energy prices around the world.

That means interest rates are set to remain at 4.0 percent for several more months yet even as the U.S. Federal Reserve has slashed rates by 3.0 percentage points since September, sending the single currency to record highs against the dollar.

While there are signs that a strong euro is hitting Europe's export base, data also showed on Thursday that euro zone retail sales unexpectedly fell in February, a worrying sign that already modest consumer spending may be faltering.

"The euro zone economy has entered a protracted period of sub-trend growth, which will over time dilute underlying inflation pressures," said Martin van Vliet, economist at ING.

"The data, in our view, make it more likely that the ECB will cut interest rates later this year. But with high headline inflation at an almost 16-year high and the risk of dislodged inflation expectations the ECB seems not to be in a hurry."

A Reuters poll on Wednesday showed many economists pushing further into the future their expectations for a rate cut, from June to the second half of the year. Financial markets don't expect a cut soon either. <ECB/INT>

The euro zone figures still look better than forecasts for another month of contraction in the U.S. non-manufacturing sector when the Institute for Supply Management publishes its survey later on Thursday at 1400 GMT.

INFLATION WORRIES

Unlike the Fed, ECB policymakers in the meantime appear fixed on a common threat -- inflation.

The euro zone services input price index soared to 63.2 from February's 60.6 because of soaring energy costs while the prices charged index climbed nearly two points to 53.9, the highest since June.

ECB Governing Council member Klaus Liebscher said on Thursday that euro zone inflation, at a series record of 3.5 percent and well above the central bank's 2.0 percent ceiling, is "worryingly high and unsatisfactory."

Uneven growth could be even more of a challenge as the split appears to be intensifying.

The index of German services activity fell to 51.8, Italy's recovered slightly but remained negative with business activity at 48.8 compared with the previous month's 47.2.

The French index slipped to 57.3 from February's 58.2 and Spanish business activity contracted at the fastest pace since the survey started in 1999, dropping to 40.9 from February's 46.1. That followed an equally dismal manufacturing survey.

"The ECB is focused on the upside risks to inflation but as we go into the second quarter we are going to see some softening in their neutral stance and the emergence of a rate cut debate," said Matthew Sharratt an economist at Bank of America.

Data also released on Thursday showed Britain's service sector slowed more than expected in March as confidence fell and firms' margins were squeezed by a record rise in input prices.

(Reporting by Jonathan Cable in London, Joe Ortiz in Madrid, Gavin Jones in Rome, Brian Rohan in Paris, Dave Graham in Berlin and Jan Strupczewski in Brussels)

(Editing by Gerrard Raven)