By Francesco Canepa

FRANKFURT Inflation in the euro zone hit a two-year low a month after its economy began contracting, data showed on Tuesday, illustrating the dual impact of a steady diet of European Central Bank's interest rate hikes.

Prices rose by just 2.9% in October, their slowest pace since July 2021, a Eurostat flash reading showed, a time when the ECB was still worried about inflation getting stuck below its 2% target.

But the brisk decline from the double-digit figures of just a year ago is coming at a cost: the euro zone economy dipped by 0.1% in the three months to September, according to a separate Eurostat release, and is flirting with a recession.

The two sets of data mean the ECB is almost certainly done with raising interest rates, which are at record highs, and will now watch the effect of its an unprecedented streak of 10 straight hikes play out before making further moves.

"The data leaves the ECB firmly on hold," Dirk Schumacher, an economist at Natixis, said.

Headline inflation started falling sharply last month as the massive increase in energy prices recorded a year earlier set a higher base for the annual comparison - an effect set to fade or even reverse in upcoming readings.

But a measure of inflation that excludes energy, food, alcohol and tobacco also declined - to 4.2%, the lowest level since July 2022, from 4.5%.

That measure is viewed by the ECB as a more accurate reflection of the underlying trend and is likely to cement its expectation that inflation will slowly head towards its 2% target by 2025.

The last mile may well prove the hardest, however.

"It's now down to weaker demand grinding down inflation and that's a slow process," Natixis' Schumacher said.

It is a painful one too, with gross domestic product in the 20 countries that share the euro expected to continue contracting in the final quarter.

"It does look like the economic environment is weakening at the moment, but no sharp recession is in sight either," ING economist Bert Colijn said.

"Still, continued economic and geopolitical uncertainty alongside the impact of higher rates on the economy will weigh on economic activity in the coming quarters."

(Reporting By Francesco Canepa; editing by John Stonestreet)