Services and retail sectors inflict blows on euro zone outlook

The euro zone's economic outlook received fresh blows yesterday from falling services sector morale and tumbling retail sales, boosting expectations that the European Central Bank will leave interest rates on hold.

The RBS/Markit Eurozone Purchasing Managers Index (PMI) for services companies, which dominate the 15-nation euro region's economy, hit a five-year low in July, intensifying talk of stagnation in the bloc.

Separate data showed euro zone retail sales, an indication of consumer demand, saw their biggest ever annual fall in June, confirming that high prices of energy and food are hitting people's spending power.

Falling oil prices offered some hope for an economic revival in the fourth quarter of 2008, economists said. They noted a contraction was expected in the second quarter and prospects for the July-September period looked bleak.

"It's really bad… we cannot rule out one quarter of negative growth; we are close to that," said Gilles Moec, economist at Bank of America.

Gloomy figures increased expectations that the ECB will refrain from raising interest rates not only at its meeting today, but also for the rest of the year.

Although the the central bank is worried about inflation, which hit a record of 4.1 per cent in July, more than double the bank's target, a slowing economy is likely to dampen price pressure.

"The euro zone retail sales figures for June are the latest in a string of very weak economic data that will strengthen the hand of the doves on the ECB's governing council in blocking calls for further monetary policy tightening," said Martin van Vliet, economist at ING.

The central bank increased its main rate to 4.25 per cent from 4.0 per cent in early July, citing the need to anchor inflation expectations and send a signal to wages negotiators not to lift them excessively.

"The recent fall in oil prices offers a ray of hope. If oil prices hold on to their recent low levels, consumer spending is likely to firm in the second half of the year," said Nick Kounis, chief European economist at Fortis.

The RBS/Markit index showed inflationary price pressures remained near record levels.

"Still elevated price pressures mean the ECB will not be cutting rates any time soon to support economic activity," said Howard Archer, chief economist at Global Insight.

The euro zone PMI for services companies, which range from banks to cafés, fell to 48.3 in July from 49.1 in June, unrevised from the flash estimate and well below the 50.0 mark that separates growth from contraction.

The French services PMI plummeted to 47.5, its lowest since the survey began in 1998, while Italy slipped into further contraction to a survey low of 45.6.

Spain had a small rebound but remained well below the 50.0 level at 37.1.

Germany fared a little better and remained in growth territory at 53.1, ticking up from June's 52.1.

European Union statistics office Eurostat meanwhile said that the euro zone's retail sales declined 3.1 per cent yearly, the biggest annual fall since measurements started in 1996 and worse than expected. The figure fell 0.6 per cent month-on-month.

Eurostat revised down its retail sales data for May to an increase of 0.5 per cent month-on-month from 1.2 per cent initially reported.

It also revised downwards the annual figure for May to a drop of 0.1 per cent from a 0.2 per cent increase. In Germany, the euro zone's biggest economy, retail trade fell by 1.4 per cent. Among euro zone countries, the biggest falls were 4.1 per cent in Austria, and 2.3 per cent in Portgual.

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