March 14, 2012 / 12:11 PM / 5 years ago

Inflation weighs on euro zone, factories recover

BRUSSELS (Reuters) - Energy prices drove up the cost of living in the euro zone in February, likely to drag on a still-stagnant economy and dampening any sense of relief that Europe's debt crisis is easing.

Energy costs were 9.5 percent higher in February than the same month a year ago, breaking a fall in euro zone inflation and pushing consumer prices up to 2.7 percent in the month, the European Union's statistics office Eurostat said on Wednesday.

While inflation is below last year's peak of 3 percent, economists and the European Central Bank had expected prices to fall steadily in 2012 as the euro zone slips into recession. Lower prices could have given some relief to households at a time of rising unemployment and sharp spending cuts.

Industrial output data, also published on Wednesday, offered some hope the economy was beginning to restart, showing factories expanding by 0.2 percent across the bloc as a whole.

"Inflation biting into the economy is quite damaging ," said Marco Valli, chief euro zone economist at Unicredit. "Any further rises in prices would be a risk to growth," he said.

Euro zone prices rose for all goods and services except for communications and education in February, compared to January. Energy prices jumped 1.1 percent on the month.

Tensions between the West and Iran over its nuclear program have driven up world oil prices, even as economic growth in the global economy - notably China - cools.

Saudi Arabia and other Gulf producers have said oil prices could spike if tensions over Iran do not subside soon although the Saudis have promised to fill any gap in supplies.

The ECB kept interest rates at 1 percent this month, judging that low rates were crucial to stimulating growth and that underlying pressures on prices seem limited for the time being.

Still, ECB President Mario Draghi said last week that rising energy prices would likely push inflation above 2 percent in 2012 "with upside risks prevailing."

That is above the ECB's target of below, but close to 2 percent, which the Frankfurt-based bank judges to be right for price stability and a healthy economy.

"Even so, ECB rate hikes remain a very distant prospect," said Martin van Vliet, an economist at ING. "The ECB may bark but it is unlikely to bite."

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"NOT MUCH COMFORT"

A slight rise in industrial production in the euro zone in January - ending two consecutive monthly falls - pointed towards the bloc's eventual recovery from recession later this year.

If factory output remains in positive territory for the next few months, that would signal a better performance than the fourth quarter's 2 percent fall and could boost GDP growth.

The devastating impact of the euro zone's debt crisis appears to be lessening after the ECB made 1 trillion euros available to banks and EU leaders signed a pact committing governments to budget austerity, reassuring investors.

Seasonally-adjusted industrial production grew by 0.2 percent from December. Factories in Germany performed better, with output climbing 1.5 percent in the euro zone's top economy.

But the euro zone's growing divide between the prosperous north and the depressed south was clear. Production fell by 2.5 percent in Italy and by 0.2 percent in Spain, the euro zone's third and fourth largest economies, respectively.

The overall rise in production was still lower than the 0.5 percent increase that economists had expected, according to a Reuters poll, highlighting that life in the manufacturing sector is still tough.

A survey of purchasing managers in February showed factory output rising for the second month in a row after five straight months of falls, but with activity at low levels.

"The latest industrial figures do not provide much comfort," said Ben May, an economist at Capital Economics, noting that the increase in January in the euro zone only partially reversed December's fall of 1.1 percent.

Reporting by Robin Emmott; editing by Rex Merrifield/Patrick Graham

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