The deterioration of business in the Eurozone has reignited recession fears

Business activity in the eurozone contracted much more than expected in July, a survey showed, as demand in the bloc’s dominant service industry slumped, while factory output fell at the fastest pace since COVID-19 first emerged.

The downturn was broad-based, with the two largest economies in the eurozone – Germany and France – in contraction and likely to add to fears that the bloc could slide back into recession.

The survey also indicated that the European Central Bank’s continued campaign to raise interest rates is starting to overshadow consumers and affect the services sector.

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

The eurozone’s HCOB composite Purchasing Managers’ Index (PMI), compiled by S&P Global and considered a good measure of overall economic health, fell to an eight-month low of 48.9 in July from 49.9 in June.

That was below the 50 mark that separates growth from contraction and below all expectations in a Reuters poll predicting a modest decline to 49.7.

“Weakness was widespread across all sectors, but it was the manufacturing sector that posted another bad read,” said Paolo Grignani of Oxford Economics.

“Today’s print confirms that the deterioration in macroeconomic conditions is afoot and spreading from manufacturing to other sectors. In our base case, we expect weak growth for the second half of the year, but today’s data suggests that the risk of a slight contraction in eurozone GDP in the third quarter is increasing.”

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

The contraction in France extended into July as the services and manufacturing sectors performed worse than expected.

The euro fell and government bond yields in the bloc fell after the data was weaker than expected.

Britain’s private sector, outside the eurozone, grew at its weakest pace in six months in July as business orders stagnated in the face of rising interest rates and still-high inflation.

A price to be paid

The euro zone services PMI fell to 51.1 from 52.0, the lowest level since January and just short of the Reuters poll forecast of 51.5.

Indebted consumers are feeling the pinch from higher borrowing costs and lower prices for spending, and the new service business index fell below the break-even point for the first time in seven months.

The purchasing managers’ index covering the bloc’s manufacturing sector fell to 42.7 from 43.4. The Reuters poll had expected a slight rise to 43.5.

The index measuring output, which feeds into the composite PMI, fell to its lowest level in more than three years.

The decline came despite manufacturers reducing backlogs and lowering their prices. Factories benefited from a sharp decline in input costs due to lower demand for materials and better supply.

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

While service prices have proven more steady, any sign of easing pressures will likely be welcomed by policymakers at the European Central Bank, who have failed to bring inflation back to their 2% target despite implementing the most stringent policy tightening schedule in the bank’s history.

They will raise interest rates by 25 basis points on Thursday, adding to consumer woes, according to all economists polled by Reuters, and a slight majority of them expect another hike in September.

(Reporting by Jonathan Cable). Editing by John Stonestreet and Toby Chopra

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