Figures highlighting the deflationary threat facing the German economy and a further surge in the value of the euro have fuelled speculation of another cut in interest rates.
Annual German consumer inflation has fallen to its lowest level since October 1999 and the data show that prices have actually fallen in the last two months.
With the euro rising to within a whisker of its highest level since its launch against the US dollar, there is increasing pressure on the European Central Bank to respond by cutting interest rates at its meeting early next month.
According to provisional figures published yesterday by the Federal Statistics Office, consumer prices in Germany fell 0.2 per cent in May from April and were 0.7 per cent higher than one year earlier.
The latest data showed a clear slowdown in inflation due mainly to a drop in energy prices. The numbers raised concern that deflation could take hold in the euro-zone's largest economy.
Growth in Germany and across the euro zone will be further hit by the rise of the euro, which will hurt exporters.
The euro surged again on foreign exchange markets yesterday, trading last night just below its all-time high against the US dollar. It broke above its 1999 launch rate of $1.1747 and was close to $1.18 later.
The euro's latest surge and the falling rate of inflation is leading to forecasts of an interest-rate cut at the next meeting of the European Central Bank.
European Central Bank governing council member and Dutch central bank governor Mr Nout Wellink, an anti-inflation hawk, cautiously admitted on Friday the bank had some room to lower interest rates. The ECB's next rate meeting is June 5th.
Pointing to the German figures, Mr Austin Hughes, economist at IIB Bank, said that a half-point cut could be on the cards for the next ECB meeting. The euro was advancing against a range of currencies, he said, and this would push down inflation further and strengthened the case for a rate cut.
However, the fundamental cause of the euro's rise remains the weakness of the US dollar, due largely to concerns about the US economy and its rising current account deficit, and speculation that the "strong dollar" policy has been abandoned by the Bush administration.
Analysts believe further dollar weakness is in prospect and that the euro can soon approach its record high of $1.1880, reached shortly after the January 1999 launch.
The strength of the euro will help to bear down on inflation here by cutting the price of imports. However, it will also damage the competitiveness of companies exporting outside the euro zone, particularly to the UK and the US, the two biggest markets for Irish exporters.
The euro rose yesterday to almost 72p sterling.
The Central Bank's trade-weighted indicator - a measure of the value of the euro weighted to take into account Ireland's trading patterns - was at 102.91 yesterday, almost 11 per cent higher than one year earlier, highlighting the competitive squeeze facing exporters.
European business leaders and politicians have expressed concern about the rapid appreciation of the single currency, which opened at $1.1789 in 1999 but subsequently slumped to just above 82 US cents.
Earlier this week France's economy minister, François Mer, said a cut in interest rates "could help the restabilisation of the exchange rate".
The German employers' organisation, the BDI, said it was worried by the euro's rise, and companies like Volkswagen, Europe's biggest car maker, has warned that the euro's strength is hitting profits.
