Euro-zone inflation fell more than expected last month, increasing the European Central Bank's (ECB's) scope for a rate cut should it come under pressure to curb the euro's rapid appreciation.

Eurostat, the EU's statistics office, said yesterday that the annual rate of inflation was 2 per cent in December, down from its provisional estimate of 2.1 per cent. Inflation in November was 2.2 per cent.

The latest Irish inflation rate - using the EU measure - was 2.9 per cent for December, meaning the rate of price increase here remains above the average. Headline Irish inflation, as measured by the consumer price index, fell under 2 per cent in December, but this includes the impact of low mortgage interest rates (which are excluded for the basis of EU comparisons), which use a measure known as the harmonised index of consumer price.

The drop in EU inflation reported yesterday largely reflected a slowdown in food and energy price rises, as the impact of last summer's drought faded and the strong euro offset import price pressures, said economists.

Inflation is expected to move even lower as the strength of the euro, which has risen about 20 per cent against the dollar over the past year, reduces import costs further and forces domestic producers to keep prices down. Yesterday the euro edged up to almost $1.2650, up from just below $1.26 the previous evening.

Core inflation - which excludes energy, food, alcohol and tobacco - remained steady at 1.6 per cent and showed that underlying price pressures in the 12-nation bloc remained weak, economists said. Barring a renewed oil price spike, the headline inflation rate is expected to fall under the ECB's "below but close to 2 per cent" price stability target in coming months.

Favourable statistical effects, as the result of a sharp rise in energy prices in February-March last year and appreciation of the euro, could drive inflation as low as 1.5-1.7 per cent in March.

The ECB remains more cautious, stressing that inflation is expected to fluctuate at around 2 per cent in coming months before falling later in the year. The bank has projected an inflation rate of 1.8 per cent for 2004.

But the bank will be presented with updated inflation projections at its rate-setting meeting in March.

Economists believe there is a growing chance the ECB, which has been fretting about "sticky" inflation, will find that prices rose less than it expected, although much depends on planned indirect tax rises.

Economists' views are divided on the likelihood of an ECB rate cut. The current level of base interest rates had been seen as the floor, with increases likely later this year, but a further rise in the value of the euro could lead to one more reduction.