May 29 (Bloomberg) -- Loans to households and companies in Europe grew at the slowest pace on record in April as banks tightened credit standards and demand for debt wilted.

Loans to the private sector rose 2.4 percent from a year earlier after increasing an annual 3.2 percent in March, the European Central Bank said today. On the month, loans to the private sector fell 0.2 percent, their third straight decline. M3 money-supply growth, which the ECB uses as a gauge of future inflation, slowed to 4.9 percent from 5 percent.

The worst recession since World War II has prompted companies to scale back investment and also made banks more wary of lending. The ECB, which has cut borrowing costs to a record low, this month said it will loan banks as much money as they need for up to 12 months and pledged to buy 60 billion euros ($84 billion) of covered bonds in an effort to revive lending.

“The decrease of loans to the private sector reflects a weakness in demand but also shows the tightening of credit conditions,” said Juergen Michels, chief euro-region economist at Citigroup Inc. in London. “While the risk of deflation is low, one shouldn’t neglect it.”

Inflation in the 16-nation euro area slowed to zero in May for the first time on record, the European Union statistics office in Luxembourg said today.

Deflation Risk

European consumers expect prices to fall more steeply over the next 12 months than they did a month ago, adding to evidence that deflationary pressures are building in the 16 nations that use the euro, a European Commission report showed yesterday.

In the three months through April, annual M3 growth slowed to 5.2 percent from 5.6 percent in the three months through March, the ECB said today. M3 is the broadest gauge of money supply and includes cash in circulation, some forms of savings and money-market holdings.

Demand for the most liquid assets increased. The annual rate of M1 money-supply growth rose to 8.4 percent from 5.9 percent in March.

The ECB this month reduced its benchmark rate to 1 percent, citing “a more broad-based reduction in inflationary pressure,” and President Jean-Claude Trichet didn’t rule out taking it lower. “We did not decide that the new level of our policy rates was the lowest level,” he said.

To contact the reporter on this story: Christian Vits in Frankfurt cvits@bloomberg.net

Last Updated: May 29, 2009 05:06 EDT