Europe's economy contracted in Q2 for the first time since the euro was launched more than 10 years ago, as exports underperformed and energy costs cut into consumers' disposable income, Eurostat, the European Union's statistics office announced (PDF) Thursday.

Euro-zone Q2 GDP fell 0.2% and EU27 Q2 GDP -- which includes nations in the European Union but not formally a part of the euro currency system -- fell 0.1%, Eurostat said. In Q1, Euro-zone GDP rose 0.7%.

Further, on a year-over-year basis, euro-zone GDP increased 1.5%, with inflation running at about 4.0%, well above the European Central Bank's 2.0% annual limit.

Economist: 'Bad news for global economy'

Economist David H. Wang told BloggingStocks Thursday Europe's slowing economy "is bad news for the global economy."

"This is bad news because we need European growth to prevent a global economic slowing. But the economies in two major European economies are clearly slowing. Germany's GDP fell 0.5% in the first quarter, and France's fell 0.3% in the second quarter, so given their make-up in the euro-zone, Europe has experienced a pronounced slowing," Wang said.

Inflation in Europe's euro-zone accelerated in May 2008, as the rising price of oil took its toll on prices at the consumer level.

Inflation increased to a 3.6% annual rate in May 2008, up from a 3.3% annualized rate in April 2008, EuroStat, the European Union's economics statistics office, announced Friday (pdf). It was the highest year-over-year inflation increase in 16 years.

Economists surveyed by Bloomberg News had expected euro-zone inflation to register a 3.5% annual pace in May 2008.

The European Central Bank's official inflation target is below 2%. The ECB has failed to keep inflation below this level for 10 consecutive years.

Further, although inflation had trended up above 3% in recent months, economists had argued that inflation still was not high enough on the continent to rule-out a reduction in short-term interest rates.

To jump-start the U.S. and regional economies, the U.S. Federal Reserve has cut short-term interest rates by 325 basis points to 2% since September 2007, while the Bank of England has cut its key rate three times to 5%. Meanwhile, the ECB has kept its key rate the same, at 4%, with ECB President Jean-Claude Trichet repeatedly underscoring the risk to the euro-zone economy from high-oil-cost-driven rising inflation.

Hence, May 2008's accelerating inflation may very well convince the ECB to not only maintain interest rates at current levels, but raise rates as 2008 progresses.

Economic Analysis: Another negative data point for both regional and global growth, as rising euro-zone inflation gives more fodder to the ECB hawks to maintain short-term interest rates at current levels. Further, given ECB President Trichet's inflation control penchant, the odds of a rate cut stand at about 10-20%: an ECB rate freeze is not what the west needs to stimulate demand, but the ECB is not likely to budge, unless euro-zone GDP growth slows considerably in Q3 2008.