June 30 (Bloomberg) -- European consumer prices recorded their first annual decline this month as energy costs fell and the economic slump pushed unemployment to a 10-year high.

The 0.1 percent drop in euro-region prices is the first since compilation of the data began in 1996, the European Union statistics office in Luxembourg said in an initial estimate today. Loans to households and companies in Europe grew at the slowest pace on record in May, a separate report from the European Central Bank showed today.

The worst recession in six decades is prompting companies to cut prices just as a 50 percent decline in the price of oil in the past year erodes fuel costs. While the ECB says it doesn’t expect a spiral of falling prices, inflation in Germany has dropped to zero and prices in Spain and Ireland have been slipping since March.

“While the euro area’s current flirtation with deflation is likely to be temporary, reflecting energy prices, inflation is still set to undershoot the ECB’s target both this and next year, and probably in 2011,” said Colin Ellis, European economist at Daiwa Securities in London.

Inflation in the euro region is now the lowest since 1953, Royal Bank of Scotland Group Plc estimates. The ECB aims for inflation to be just under 2 percent.

ECB President Jean-Claude Trichet has said he expects inflation to “temporarily remain negative over the coming months” before turning positive by year-end. ECB Executive Board member Lorenzo Bini Smaghi said this month he doesn’t expect the euro region to experience deflation.

Price Cuts

RWE AG, Germany’s second-biggest utility, plans to cut consumer natural-gas tariffs by up to 15 percent on July 1, while Spanish supermarket chain Mercadona SA has reduced prices by an average 10 percent. In Ireland, retailers Tesco Plc and Marks & Spencer Group Plc are lowering prices.

A gauge of euro-area consumers’ price expectations declined in June to a record low, the European Commission said yesterday, even as oil prices have begun to increase, with crude oil doubling since the middle of February.

“It’s interesting that this is coming in spite of higher energy prices, as typically these surveys are very sensitive to energy prices,” Luigi Speranza, an economist at BNP Paribas in London said. “By this time next year, inflation will be still very low and well below the ECB’s definition of price stability.”

Inflation Target

The ECB, which targets an inflation rate of just under 2 percent, held its benchmark interest rate at a record low of 1 percent on June 4. It also forecast that consumer-price growth would average 0.3 percent this year and 1 percent in 2010.

Unemployment probably rose to 9.4 percent that month, the highest since 1999, according a Bloomberg survey of economists. The EU statistics office will publish the jobless data on July 2.

“The bottom line is we have a very low inflation environment but we’re not in a deflation situation,” said Nick Kounis, chief European economist at Fortis Bank in Amsterdam, who correctly forecast the June rate.

The central bank is also lending banks as much money as they want for 12 months to get credit flowing and plans to buy 60 billion euros ($84.6 million) of covered bonds from next month.

‘Timely Withdrawal’

Some policy makers, including Germany’s Axel Weber, have said the ECB must withdraw its monetary stimulus quickly once the economy returns to growth to prevent the build-up of inflationary pressures.

“A timely withdrawal of liquidity” is necessary to ensure price stability, Weber said on June 23. “The past has shown that an overly generous provision of liquidity in global financial markets in connection with a very low level of interest rates promotes the formation of asset-price bubbles.”

The inflation report released today is an estimate. The statistics office will publish a detailed breakdown of the data, including energy-price inflation as well as the core rate, on July 15.

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net

Last Updated: June 30, 2009 05:52 EDT