---- by Stuart Williams ----
FRANKFURT (AFX) - The European Central Bank should cut interest rates at its next governing council meeting on July 5 after today's Ifo index raised the possibility of a recession in Germany and inflation showed signs of moderation, analysts said.
Economists said the Ifo index of business confidence was far worse than expected with the headline index coming in at 90.9 points, well below the market concensus figure of 91.6. It was the fourth consecutive fall.
In addition, preliminary June inflation figures from Germany's states showed a moderation after hikes in May, which pushed euro zone HICP inflation up to 3.4 pct.
"In this environment the ECB should take the opportunity of slightly lower inflation in June to cut rates", said Holger Fahrinkrug at UBS Warburg.
"We look for 25 basis points soon, with a good chance this happens at the next ECB Council meeting", he added.
Inflation in Baden-Wuertemburg rose 0.3 pct month on month in June after a 0.5 pct rise last month, while prices in Hessen rose by only 0.2 pct from May.
Guillaume Menuet at 4Cast said the headline Ifo figure had fallen far more than expected. "July 5 will certainly be the best time as inflation is now falling. Why should they (the ECB) wait?"
Klaus Baader at Lehman Brothers said: "The ECB will now cut interest rates by 25 basis points at its next meeting."
Ulla Kochwasser at IBJ Research said the inflation data makes it probable euro zone inflation reached a peak in May, echoing comments by ECB president Wim Duisenberg yesterday. Duisenberg said it is "not unlikely" inflation peaked in May.
Kochwasser said the ECB does not have the room for manoeuvre for substantial interest rate cuts, but it will look to make a psychological move to boost economic confidence.
"An interest rate cut is now very probable on July 5. Things are going down rapidly and not only in Germany", she said.
Economists said today's data has underlined the looming possibility of a recession in Germany, as defined by the technical definition of two quarters without growth.
Speaking after the Ifo data was released, Bundesbank council member Hans Helmut Kotz said the chance of a recession in Germany cannot be excluded.
"It's still looking like Germany might go into recession", agreed 4Cast's Menuet. "According to our forecasts there will be a flat second quarter and possibly negative growth in the third."
Economists said the question is whether tax cuts being introduced during the year will stimulate consumer demand sufficiently to prevent the manufacturing sector dragging the whole economy into recession. UBS Warburg's Fahrinkrug said he expects four quarters of negative output growth. "GDP growth will remain more robust but a slightly negative quarterly growth rate in Germany for second quarter is conceivable as both industry and consumers will have performed badly."
Economists said the ECB has limited room to help Germany's sagging economy as the country's economic malaise is partly self induced. "Germany's problems are more homemade so there is a limit to what monetary policy can do. Reforms to the construction and labour markets really are quite urgent", said IBJ's Kochwasser.