The euro tumbled against the dollar yesterday as evidence of plunging inflation and slumping services activity in the eurozone fuelled speculation over further, early cuts in interest rates by the European Central Bank (ECB).

Pressure on the ECB to cut eurozone rates again next week intensified as official figures confirmed that inflationary pressures in the single currency area are evaporating.

In a drop that was much sharper than expected, headline eurozone inflation fell to an annual rate of only 1.6 per cent last month - sharply down from 2.1 per cent in November, and peaks of 4 per cent hit in June and July.

The decline in price pressures brought inflation in the 16-nation bloc into line with the ECB's target level of “close to, but below 2 per cent” for the first time since August 2007.

Economists said that, while no breakdown of the inflation data was available in yesterday's initial, “flash” estimate, the steep slide in the pace of price increases was almost certainly driven largely by the plummeting price of oil and petrol, as well as falls in the cost of some food products.

The case for the Frankfurt-based ECB to take further action this month to bolster the eurozone economy and lower rates again from their present 2.5 per cent level was reinforced by the latest bleak news of conditions in the bloc's sprawling services sector.

Already rapidly declining activity among services businesses fell at a still faster pace last month, according to the latest purchasing managers' survey of the sector from Markit. Its headline index of conditions fell to 42.1 for December, from a November reading of 42.5, on a scale where any figure under 50 points to overall contraction.

Javier Pérez de Azpillaga, European economist at Goldman Sachs, said that the grim trend in the data was consistent with eurozone GDP having plunged by 0.6 per cent in the final quarter of last year - three times the 0.2 per cent contraction suffered in the previous three months.

Services data for France were particularly dire, with the index of the sector's activity in the eurozone's No 2 economy sliding to 40.6 last month, from 46.2 in November.

There was slightly rosier news from other parts of Europe, with the headline gauges of services conditions in Germany and Italy ticking up a little, while the index for Spain rose more sharply after a large drop in November. Mr Pérez de Azpillaga said that these trends could suggest that some stabilisation might be taking hold, but he added that “a less optimistic interpretation is that the recoveries are just 'dead-cat bounces' from the November drops”.

Howard Archer, of IHS Global Insight, said that yesterday's figures made a “compelling case for the ECB to cut interest rates significantly further ... While the ECB is currently keeping its cards close to its chest, and has indicated some reluctance to cut rates, we believe it is more likely than not to act at its January 15 meeting.”

Expectations that the ECB will cut rates weighed heavily on the previously potent euro, sending the single currency into a sharp retreat against the dollar. The euro fell by as much as 1.5 per cent against the greenback, dropping to $1.3311, its weakest dollar value since December 12, as foreign exchange traders bet on an ECB move.

The euro's losses paved the way for the pound to claw back some of its recent sharp losses, with sterling gaining 2.8 per cent against the euro to €1.0978. The pound also rose more than a cent against the dollar to close in London at $1.4686.

In the zone

1.5% The euro's fall yesterday against the dollar

91.09p Yesterday's London close for the euro against the pound

0.6% The pace of contraction predicted in the eurozone over the past quarter

2.5% The present level of eurozone official interest rates

Sources: Thomson Financial; Reuters; Goldman Sachs; ECB

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