(Recasts with final data)
By Dave Graham
BERLIN, Jan 28 (Reuters) - German inflation unexpectedly eased close to a five-year low in January, fuelling expectations of a slowdown in price pressures in the euro zone which could help real wages and shore up flagging domestic demand.
Germany's national gauge of consumer prices (CPI) showed inflation slowed to 0.9 percent from 1.1 percent in December, the lowest rate since February 2004, official data showed on Wednesday. Month-on-month, prices declined by 0.5 percent.
The preliminary data from the Federal Statistics Office showed inflation slowing for the sixth month in succession, pointing to a parallel development in the euro area and prompting some analysts to highlight the risks of deflation.
However, economists cautioned the data would not necessarily prompt the European Central Bank (ECB) to make further substantial cuts to euro zone interest rates.
A Reuters poll conducted last week forecast inflation in 16-nation currency bloc would ease to 1.4 percent in January from 1.6 percent in December. Euro zone data are due on Friday.
Alexander Koch, an economist at Unicredit, said so far the price falls should be seen as "healthy disinflation", which supported the purchasing power of private households.
However, he added: "Worrisome deflation remains a risk scenario. Only if the global recession continues or even deepens in the second half of the year, (would) the probability for sustained deflation...rise substantially."
Publishing its latest outlook for German consumer spending on Wednesday, the GfK market research group said low inflation rates were encouraging shoppers to open their wallets.
Germany's EU-harmonised price index (HICP) fell by 0.6 percent on the month. Year-on-year, HICP rose by 0.9 percent, compared with a gain of 1.1 percent in December.
Bundesbank President Axel Weber said earlier this week that negative German inflation rates were likely in coming months.
Month-on-month, the German CPI was expected to show prices falling by 0.3 percent, with HICP seen down by 0.4 percent. The annual rate for both was seen holding at 1.1 percent.
FUTURE RISKS
Nick Kounis, an economist at Fortis bank, said inflation in the bloc should remain below the ECB's target rate of just under two percent for now.
"Inflation is likely to continue to fall in the coming months and will probably settle comfortably below the ECB's price stability goal over the medium term, suggesting that the central bank can cut rates further," Kounis said.
The Bank of Spain forecast on Wednesday that euro zone inflation could fall close to zero around the middle of 2009 before picking up again later in the year.
Heinrich Bayer, a Postbank economist, said though the ECB might lower its main lending rate from 2.0 percent in March, it might adopt a more cautious strategy, mindful of future risks.
"At the moment, all the talk is of deflation," he said.
"However, with the amount of liquidity that has been pumped into the system, there is a risk of a spike in inflation later this year. Euro zone inflation could accelerate towards two percent in the autumn, so the ECB may wait and see on rates."
"The further they cut them now, the quicker they will have to raise them again afterwards," Bayer added.
On Tuesday, analysts took heart from an unexpected rise in the Ifo economic research institute's gauge of German business sentiment in January. This showed expectations among firms had improved for the first time in eight months.
In an interview with Reuters in Brussels, Martin Wansleben, managing director of Germany's DIHK chambers of industry and commerce, said the country's firms were not suffering from a credit squeeze despite the global financial crisis. (Additional reporting by Brian Rohan, Paul Carrel and Ilona Wissenbach; Editing by Toby Chopra)