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BLBG: ECB's Key Inflation Gauge Falls to 3-Month Low as Growth Wanes
By Anchalee Worrachate

Oct. 2 (Bloomberg) -- A key inflation gauge used by the European Central Bank fell to a three-month low as ECB President Jean-Claude Trichet said policy makers discussed cutting interest rates today to revive the region's faltering economy.

Inflation expectations as measured by the so-called five- year/five-year forward breakeven rate fell to 2.52 percent today from 2.66 percent yesterday, the lowest level since July 9. The ECB kept its benchmark interest rate at a seven-year high of 4.25 percent today even as data reinforced evidence that growth is faltering. The measure is one of the bank's ``very, very important indicators,'' Trichet said Sept. 4.

``The economic outlook is subject to increasing downside risks'' mainly ``stemming from ongoing financial-market tensions,'' Trichet told reporters in Frankfurt today after rate decision. As a result, ``upside risks to price stability have diminished somewhat, but have not disappeared.''

The five-year/five-year forward is a five-year expected inflation rate five years from now. The financial crisis reached new heights in Europe this week as governments stepped in to rescue five banks and credit costs soared to records.

The euro-region economy shrank in the second quarter, unemployment rose to the highest in more than a year in August and the manufacturing, services and retail sectors all contracted for a fourth month in September. Confidence in the economic outlook is the lowest since the aftermath of the Sept. 11, 2001 terrorist attacks, according to the European Commission.

``The renewed market turmoil raises the already clear downside risks to growth globally, including Europe, in turn pointing to lower inflation rates going forward,'' said Richard McGuire, a senior fixed-income strategist in London at Royal Bank of Canada. ``The ECB will cut interest rates early next year, but the risks are increasingly slanted toward that being brought forward.''

To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net;