By Susan Mathew and Devik Jain
(Reuters) -European shares fell on Wednesday as higher than expected U.S. inflation data raised bets about more aggressive Federal Reserve policy action, and also put pressure on the European Central Bank after the euro tumbled to parity with the dollar.
The pan-European STOXX 600 index ended 1% lower after data showed U.S. consumer prices surged 9.1% last month, the largest annual increase in more than four decades amid stubbornly high costs for gasoline, food and rent.
Automobiles, construction and materials were the biggest European sectoral losers, down 2.3% and 1.8%, respectively.
While a 75 basis points interest rate hike by the Fed this month was more or less priced in, the data supported expectations of even bigger increases.
"With inflation getting even further offside, the Fed may be looking at third option at its upcoming meeting: a 100 bps hike," economists at Wells Fargo wrote in a note.
"To be clear, a 100 bps rate hike is not our base case at present, but yet another surprisingly strong CPI report cracks the door to such a move should the FOMC decide to bang that door wide open," they said.
As the U.S. currency rallied, the euro fell below $1 per dollar for the first time in almost two decades, putting the ECB in a bind. The central bank is expected to raise interest rates next week for the first time since 2011 to combat inflation running at a record high of 8.6%.
Currency weakness exacerbates the inflation problem and rapid interest rate rises could add to pressures on the euro zone economy already facing a possible recession, looming gas shortages and sky-high energy costs that are depleting purchasing power.
"We think Europe has a higher risk of getting into recession than the U.S.," said Ankit Gheedia, Head of Equity and Derivatives Strategy, Europe, at BNP Paribas.
"Given that equity valuations are already reflective of 20% earnings compression in Europe, we think there will be further 20% downside from here if there's no gas supply," Gheedia said.
"So with all that in mind, market is not fairly priced for ECB in that kind of recession scenario."
The STOXX 600 index and the eurozone blue-chips index have fallen 15.4% and 19.6% year-to-date as investors fear aggressive policy tightening will squeeze growth.
Among individual stocks, Orion jumped 9.2% as the Finnish drug maker upgraded its full year outlook after signing a collaboration deal with Merck.
(Reporting by Susan Mathew and Devik Jain in Bengaluru; Editing by Rashmi Aich, Jonathan Oatis and Jane Merriman)