Inflation Fall

The fall in oil prices raised the prospects that consumer prices might have peaked, which would help ease pressure on the European Central Bank.

"That is a big decline," said Klaus Baader, Merrill Lynch's London based chief European economist. "It is astonishing how rapidly the fall in oil prices has fed through to inflation."

The inflation data published on Friday, Aug. 29, follows the release of data earlier this week showing inflation in key economies starting to ease with a slide from 3.3 percent in July to 3.1 percent in August in Germany.

Analysts had expected the European Union's statistics office's preliminary inflation data to show consumer prices in the euro zone coming in at 3.9 percent this month.

This came after a decrease in oil prices in recent weeks from record highs of around $150 a barrel (102 euros) to below $120 (81 euros).

Challenges ahead for euro zone

However, the data also revealed further signs of the low consumer confidence currently prevailing in the euro zone, with the European Commission's closely watched economic sentiment survey for the currency bloc falling more than expected to 88.8 points in August.

"The low level of the indicator suggests that industrial activity remains subdued," the Commission said.

Yet it is the first time in a year that the commision's consumer indicator has risen, which suggests that the drop in oil prices and the release of national euro zone data showing inflation edging down in several euro zone states appears to have helped improve the mood.

The ECB is expected to leave interest rates on hold at its meeting next week as it attempts to size up the economic fallout from shrinking growth and high inflation.

But inflation still remains at almost double the ECB's target of "close to, but just below 2 percent," with recent warnings from key members of the Frankfurt-based central bank of the threat posed by resurgent inflation.

In particular, some of the ECB's 21 member rate-setting council have expressed concerns about the risks of high inflation fuelling so-called second-round effects of rising prices, triggering demands for higher wages.

Evidence of inflationary pressures emerging in the euro zone prompted the ECB to raise rates for the first time in more than a year in July, with the bank raising its refinancing rate by 25 basis points to 4.25 percent.

The ECB still faces the problem of the credit crunch and slowing global growth having helped to push several economies such as Spain, Ireland and Italy to the brink of recession.