The oxidation of CO by Fe2O3 clusters has been studied using a first principles gradient corrected density functional approach. It is shown that the direct oxidation of CO via surface oxygen atoms is feasible with a low barrier of 0.4 eV. The present studies also suggest a new indirect mechanism for CO oxidation. Here, the first CO molecule adsorbed on a surface Fe site breaks one of the FeO bonds and a subsequent CO molecule is oxidized by the less coordinated O atom in an almost barrierless reaction pathway. Subsequent attachment of CO and O-2 to Fe sites results in the formation of a CO3 complex where the heat of formation is enough to allow CO, to leave the surface reverting the system back to Fe2O3. The role of charge transfer and the nature of the transition states are highlighted. It is shown that small clusters are ferromagnetic indicating that super-exchange interactions of the antiferromagnetic bulk are modified at the reduced sizes. (C) 2004 Elsevier Ltd. All rights reserved.