Eurozone business downturn deepens to reignite recession woes

Economic activity in the eurozone contracted much more than expected in July, a closely watched survey showed on Monday, as demand in the bloc's dominant services industry declined while factory output fell at the fastest pace since COVID-19 first took hold.

HCOB's flash Composite Purchasing Managers' Index (PMI) for the bloc, 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.

"Manufacturing continues to be the Achilles heel of the eurozone. Producers have cut their output again at an accelerated pace in July, while the services sector's activity is still expanding, though at a much slower rate than earlier in the year," said Cyrus de la Rubia, at Hamburg Commercial Bank.

"The eurozone economy will likely move further into contraction territory in the months ahead, as the services sector keeps losing steam."

The decline was broad-based with the eurozone'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 (ECB) sustained campaign of interest rate rises is starting to take its toll on consumers and dent 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.

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

"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 eurozone 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 eurozone, is growing at its weakest pace in six months in July, a separate survey showed, as orders for businesses stagnate in the face of rising interest rates and still-high inflation.

Price to pay
The eurozone services PMI fell to 51.1 from 52, 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 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 42.9 from 44.2 – a low not hit in over three years.

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% target despite implementing the most aggressive policy tightening schedule in the bank's history.

The Frankfurt-based institution will raise interest rates by 25 basis points on Thursday in its quest to tame red-hot inflation, according to all economists in a Reuters poll, a slight majority of whom expect another hike in September.

Eurozone inflation eased to 5.5% in June as energy costs slid, but those of food and drinks remained elevated as underlying price pressures persist.

The eurozone entered a technical recession at the start of the year, and growth is forecast to be weak this year at around 1%.

"The latest PMI reading is not going to please ECB officials as prices in the private sector are still creeping up, led solely by the substantial services sector," de la Rubia said.

"Thus, ECB president Christine Lagarde will certainly stick to her guns and hike interest rates by 25 bp (basis points) at the next monetary meeting."

Key rates have risen by 4 percentage points since July last year, with the ECB's deposit rate now sitting at 3.5% – its highest level since 2001.