Worsening euro zone business downturn reignites recession fears

Workers assemble campers at Knaus-Tabbert AG factory in Jandelsbrunn near Passau, Germany, March 16, 2021. REUTERS/Andreas Gebert/File photo

LONDON  -Euro zone business activity shrank much more than expected in July as demand in the bloc’s dominant services industry declined while factory output fell at the fastest pace since COVID-19 first took hold, a survey showed.

The decline was broad-based with the euro zone’s two biggest economies – Germany and France – both in contractionary territory and will likely add to fears the bloc will slip back into recession.

The survey also indicated the European Central Bank’s sustained campaign of interest rate rises is starting to take its toll on consumers and denting the services sector.

This will pose questions for the bank, which meets on Thursday, as it weighs its fight against record inflation against the economic damage it could cause.

HCOB’s flash Composite Purchasing Managers’ Index (PMI) for the euro area, compiled by S&P Global and seen as a good gauge of overall economic health, dropped to an eight-month low of 48.9 in July from June’s 49.9.

That was below the 50 mark separating growth from contraction and lower than all expectations in a Reuters poll which had predicted a modest dip to 49.7.

“The weakness was widespread across all sectors, but it was the manufacturing sector that posted another bad reading,” said Paolo Grignani at Oxford Economics.

READ: Euro zone business growth stalls in June -flash PMI

“Today’s print confirms the deterioration in macroeconomic conditions is well underway and spreading from manufacturing to other sectors. In our baseline case we expect subdued growth for the second half of the year, but today’s data suggest the risk of a small contraction in euro zone GDP in Q3 is increasing.”

Activity in Germany, Europe’s largest economy, contracted in July, increasing the likelihood of a recession in the second half.

In France a downturn extended into July as both the services and manufacturing sectors did worse than expected.

The euro slid and the bloc’s government bond yields fell after the softer than expected data.

The private sector in Britain, outside the euro zone, is growing at its weakest pace in six months in July as orders for businesses stagnate in the face of rising interest rates and still-high inflation.

A price to pay

The euro zone services PMI fell to 51.1 from 52.0, its lowest since January and shy of the Reuters poll forecast for 51.5.

Indebted consumers feeling the pinch from rising borrowing costs and prices cut back on spending, and the services new business index went below breakeven for the first time in seven months.

A PMI covering the bloc’s manufacturing sector dropped to 42.7 from 43.4. The Reuters poll had forecast a slight rise to 43.5.

An index measuring output, which feeds into the composite PMI, fell to its lowest in over three years.

READ: Euro zone factory downturn deepens in May despite price cuts

The decline came despite manufacturers running down backlogs of work and cutting their prices. Factories benefited from a sharp drop in input costs due to falling demand for materials and improved supply.

“Input price pressures continued to ease, but this was almost entirely due to costs falling in the manufacturing sector, which in turn probably reflects lower energy prices as well as improved global supply conditions,” said Jack Allen-Reynolds at Capital Economics.

While prices in services proved stickier, any sign of easing pressures will probably be welcomed by policymakers at the ECB who have failed to get inflation back to their 2 percent target despite implementing the most aggressive policy tightening schedule in the bank’s history.

They will raise interest rates by 25 basis points on Thursday adding to the woes of consumers, according to all economists in a Reuters poll, a slight majority of whom expect another hike in September.

READ: Euro zone lending takes another hit from higher rates