4th UPDATE: German States' July CPI Falls On Year

FRANKFURT -- German consumer prices in July are likely to have fallen on the year for the first time in over 20 years, based on data published Wednesday by six of the country's largest federal states.

The data may usher in what European Central Bank officials expect to be a brief period of deflation in Germany and across the euro zone in general.

They also suggest strongly that prices fell more sharply in July than the market expected, after surprising on the upside in June. Analysts polled by Dow Jones Newswires had expected prices to have risen 0.1% on the month and to have fallen 0.3% from a year earlier.

Prices fell from June in all but one of the early-reporting states in western Germany: by 0.2% in North Rhine Westphalia and Hesse, and by 0.1% in Baden-Wuerttemberg. In Bavaria, prices were flat on the month. In all four cases, prices hadn't fallen in annual terms since 1987, and the price declines ranged from 0.2% in Bavaria to 0.9% in Hesse.

In the eastern states of Saxony and Brandenburg, which incorporates the capital Berlin, prices were flat on the month and fell 0.6% from a year earlier - the sharpest annual decline in prices since either state joined the Federal Republic in 1990.

All six state statistics offices pointed to the sharp drop in energy prices over the last year as being chiefly responsible.

Crude oil prices had peaked at over $147 a barrel in the summer of 2008, and have more than halved since then. Gasoline prices at the pump have fallen by around 20% in that time, the statistics offices reported.

Food prices have also fallen in the last 12 months after a worldwide price spike in 2007 and early 2008. The first five states to report showed they had fallen by between 2.5% and 3.0% since July last year.

A preliminary figure for Germany will be published later in the day. Alexander Koch, an economist with UniCredit SpA unit Hypovereinsbank in Munich, said he expects the pan-German CPI to have fallen around 0.5% on the year, judging by the individual states' data.

But he noted that the headline CPI is likely to increase again after "two or three months" and be clearly above zero by the end of the year, as the bursting of last year's energy price bubble comes into the calculations.

"The chances of the inflation rate staying negative or close to zero for a long time are slim," Koch said.

The ECB has said it expects consumer prices across the euro zone to fall for a few months in the second half of 2009, but for inflation to return to the bank's targeted level of "close to, but below 2%" in the medium term.

Some leading price indicators are already starting to show signs of turning, as demand picks up and confidence returns to Germany's manufacturing sector after the global financial crisis caused the sharpest drop in output since World War II. Prices for imports stabilized in May and rose 0.4% in June, while prices for exports also rose in June, up 0.1%.