A destructive combination of deflation and plummeting output loomed over the United States yesterday after another double dose of grim economic news.

A plunge in the American headine inflation rate to lows of virtually zero not seen for more than half a century and the sharpest annual slump in production at factories for 33 years fuelled fears of a vicious recession.

Anxieties over the latest severe blows to US prospects came as concerns over the depth of the recession facing other leading economies were stoked by more evidence from Europe that world trade is rapidly collapsing. But it was the latest bleak developments in the world's biggest economy that set the loudest alarm bells ringing in financial markets.

The threat that the US economy will slide into the grip of full-blown, Thirties-style deflation was underlined by yesterday's stark inflation figures. A further sharp 0.7 per cent drop in consumer prices during last month drove the headline inflation rate down to just 0.1 per cent, the weakest reading since December 1954.

For now, America remains some way from full-blown deflation, however, as so-called “core” inflation - stripping out the impact of tumbling fuel prices as well as the cost of food - remains markedly higher. Last month's core inflation rate eased to 1.8 per cent. This was still the smallest pace of increase in core consumer prices since 2003.

Fears that deflationary pressures will continue to tighten their grip were heightened by other dire industrial news as output from US factories last month sank by a steeper than forecast 2 per cent. The latest decline by industry capped a dismal year and left output down by 7.8 per cent from a year earlier, in the biggest annual fall since September 1975.

As the new US administration under President-elect Obama prepares to push through an aggressive new package of fiscal measures to try to rekindle American growth, Henry Paulson, the present Treasury Secretary tried to defend his handling of

the economic crisis and his much-amended $700 billion (£477 billion) financial bailout programme.

“I assure you that the [programme] has been absolutely essential to financial stability and financial stability is essential to everything that everyone wants to see happen economically,” Mr Paulson said. He insisted that the rescue effort had made “real progress”.

There was little respite from the tide of bleak economic developments on the other side of the Atlantic meanwhile. In the latest symptom of collapsing world trade flows, eurozone exports dropped by 4.7 per cent in November, leaving eurozone trade as a whole in deficit by €7 billion (£6.3 billion), compared with a €500 million surplus in October, and a €2.3 billion surplus a year earlier.

Despite rapidly worsening trends in the eurozone economy, Jean-Claude Trichet, President of the European Central Bank, said that, while there was room for eurozone interest rates to fall further, the ECB was not considering cutting rates all the way to zero.

“To the question, ‘is 2 per cent the lowest level that you will attain', I say no. If you ask me the question, ‘if you go to zero', I would say no,” he said in an interview with Japanese television.

His comments came after the ECB this week cut rates to 2 per cent, in its fourth rate cut in as many months.

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