(Adds economists' comments)
By Jan Strupczewski
BRUSSELS, April 6 Euro zone retail sales dropped much more than expected and producer prices fell in February, underlining the weakness of consumer demand and waning inflationary pressures in the contracting economy, data showed.
The European Union's statistics office said retail sales in the 16 countries using the euro fell 0.6 percent month-on-month in February for a year-on-year 4.0 percent decline.
Economists polled by Reuters had expected a 0.4 percent monthly fall and a 2.5 percent annual drop.
"February's fall in euro zone retail sales confirms that spending is not benefitting from sharp falls in inflation," said Jennifer McKeown, economist at Capital Economics.
Eurostat said prices at factory gates in the euro zone fell 0.5 percent month-on-month in February, as expected by markets, for a year-on-year 1.8 percent fall against forecasts of a 1.6 percent decline.
The main driver behind the annual fall in producer prices was a 4.5 percent drop in energy costs, thanks to lower prices of oil and gas.
Intermediate goods prices were down 3.1 percent and price rises for durable consumer goods and capital goods slowed for the fourth month in a row.
Retail sales are an indication of household demand, which has been under pressure from the quickly rising unemployment as the euro zone economy sinks into its worst economic crisis since the Second World War.
"Given the rapid deterioration in labour market conditions, consumer spending will probably remain very weak in the near term at least, despite the relatively healthy state of household finances," McKeown said.
Producer prices show inflationary pressures early in the pipeline as their rise or fall is usually later reflected in consumer prices, which the European Central Bank wants to keep below, but close to 2 percent.
"Trends in producer prices tend to filter through to retail prices with a lag of between 6 to 12 months," said Luigi Speranza, economist at BNP Paribas.
"Recent trends in prices at the factory gate support our view that core inflation at the consumer level will progressively slow over the next few months and we expect it to turn negative sometime next year," he said.
Consumer price growth slowed to 0.6 percent year-on-year in March from a peak of 4.0 percent in July as a result of the economic crisis and the ECB has cut its main refinancing rates by a total of 300 basis points since October to 1.25 percent.
The bank has signalled it may cut borrowing costs again by a quarter point in May and also consider other ways of monetary policy easing to help boost demand in the economy as headline inflation is likely to turn negative in mid-year.
(Editing by Andy Bruce)