Eurozone economic downturn deepened in July, business survey indicates

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The eurozone’s downturn deepened at the start of the third quarter, according to a closely watched business survey that suggested the region’s economy is shrinking.

The HCOB flash eurozone composite purchasing managers’ index, a measure of activity at companies across the 20-country bloc, fell to an eight-month low after a sharper than expected slowdown in services and a steeper decline in manufacturing in July.

The result is expected to add to calls for the European Central Bank to stop raising interest rates after a quarter percentage point rate rise expected on Thursday.

The euro fell 0.4 per cent against the US dollar to $1.108, while Germany’s two-year bond yield dropped 0.06 percentage points to 3.16 per cent as investors dialled back their bets on further tightening.

By falling to 48.9, down from 49.9 in the previous month, the PMI index dropped further below the 50 mark that separates contraction from expansion and raised fears of a potential recession in the eurozone economy after two quarters of mild contraction.

The flash eurozone reading was well below the 49.7 forecast by economists in a Reuters poll. 

The UK economy is also slowing sharply, according to a separate PMI survey published on Monday that showed the index of British business activity fell to a seven-month low of 50.7, down from 52.8 in June.

“The eurozone economy will likely move further into contraction territory in the months ahead, as the services sector keeps losing steam,” said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, adding that there was “an increased probability” of the German economy sliding into recession in the second half of this year.

The bloc’s services sector remained in growth territory, despite a drop in its PMI reading to a six-month low of 51.1. The decline in the manufacturing sector deepened further after its reading fell to a 38-month low of 42.7.

Weakening demand triggered the steepest decline in manufacturing orders since 2009, while the services sector suffered its first drop in orders for seven months. Job growth continued, albeit at the slowest pace for more than two years.

Economists think this week’s expected rate rise by the ECB could mark the end of its 12-month monetary tightening cycle if a downturn weakens the labour market and causes wage growth to slow.

However, the central bank has said in recent weeks it is concerned high wage growth and rising services prices could keep inflation above its 2 per cent target for too long.

Unemployment in the eurozone fell to a record low of 6.5 per cent in May and hourly labour costs in the eurozone rose 5 per cent in the first quarter, down from a high of 5.6 per cent in the previous quarter.

The PMI survey showed wholesale prices fell sharply in the eurozone manufacturing sector, in contrast to sustained rises in prices for services, which reflected companies passing on higher labour costs to customers. However, the rate of services inflation was the lowest since October 2021.

Claus Vistesen, an economist at research group Pantheon Macroeconomics, said the PMI survey would be “grist to the doves’ mill” in the case for the ECB to pause its rate rises after this week. But he added a “nasty” increase in second-quarter wages could still push it to raise rates again in September.

Eurozone inflation slowed more than expected to 5.5 per cent in June, it’s lowest level since Russia’s full-scale invasion of Ukraine over a year ago, and it is expected to keep declining when July pricing data is published next week. But the ECB has said it wants to see convincing evidence that core inflation — a measure that excludes energy and food costs, and is seen as a better gauge of underlying price pressures — is falling towards its target before it stops raising rates.

Bert Colijn, an economist at Dutch bank ING, said the PMI survey showed “rising wages continue to keep price pressures elevated for services”. That, he said, “keeps hawkish concerns about the effect of wages on inflation alive”.