*Sentiment defies market expectations of mild rebound
*Indicator hits lowest value since series start in 1985
*Inflation expectations fall to record lows
*Data boosts chances of deep ECB rate cut on Thursday (Adds Spanish inflation data, details)
By Jan Strupczewski
BRUSSELS, March 30 (Reuters) - Euro zone economic sentiment fell to new record lows in March along with inflation expectations among households and companies, boosting the likelihood of a deep ECB interest rate cut on Thursday.
Economic sentiment in the 16 countries using the euro fell to 64.6 points, the European Commission said on Monday in a monthly survey, from 65.3 points in February, defying market expectations of a mild rebound to 65.5 points.
Inflationary pressures are falling as quickly as economic activity, the data showed, with inflation expectations among households down to 1 point, the lowest level ever, from 5 points in February. Among companies, selling-price expectations dropped to -14 points from February's -11 points, again a new low.
The March economic sentiment reading is the lowest value since the series began in 1985. (For table see)
All of the index's components were weaker than expected, pointing to deepening economic gloom before the European Central Bank meets on interest rates amid strong expectations of a 50 basis point cut to 1.0 percent.
"Since there is close correlation between the index and the year-on-year rate of change in real GDP, today's result suggests that the euro zone economy will have contracted by roughly 2 percent quarter on quarter in the first three months of the year," said Christoph Weil, economist at Commerzbank.
"The fact that the euro zone economy has continued to contract at the start of the year will force the ECB to cut its key interest rate by 50 bps on Thursday to 1 percent and to consider additional unconventional steps," he said.
The unconventional steps economists expect are called quantitative easing -- for example when a central bank buys corporate or government debt to facilitate access to credit, as the Bank of England and the U.S. Federal Reserve have done.
Euro zone GDP contracted 1.5 percent quarter-on-quarter in the last three months of 2008. Economists said it may shrink even further, albeit at a slower pace, in the second quarter of 2009.
INFLATION EXPECTATIONS FALL
The ECB wants annual inflation to be just below 2 percent, but consumer price growth slowed already to 1.2 percent in February and is seen falling to 0.8 percent in March.
The European Union's Statistics office will publish its estimate of euro zone inflation in March on Tuesday at 0900 GMT.
Spanish data on Monday showed consumer prices in the country fell 0.1 percent year-on-year this month, the first negative annual inflation number in the euro zone during the global crisis and also the first in Spain since records started in January 1962.
Falling inflation expectations in the Commission's survey are likely to worry the ECB, which wants to keep them anchored around its inflation target.
"By revealing that companies' selling-price expectations and consumers' inflation expectations are both at record lows, the European Commission's survey adds to already strong evidence that underlying inflationary pressures are diminishing rapidly," said Howard Archer, economist at IHS Global Insight.
"The survey therefore reinforces the already compelling case for the ECB to cut interest rates further on Thursday and we expect the bank to deliver another 50 basis points reduction from 1.50 percent to 1.00 percent," he said.
Separately, the euro zone Business Climate Indicator (BCI) declined to an all-time low in March, pointing to shrinking industrial production in the first quarter of 2009, Commission data showed.
The BCI, which helps to establish the phase of the business cycle, fell to -3.58 points from a revised -3.40 in February, hitting its lowest since measurements started in 1985. Analysts polled by Reuters had expected the indicator to be at -3.48. (Additional reporting by Marcin Grajewski; editing by Dale Hudson/David Stamp)