European Confidence Drops Most Since Sept. 11 Attacks

By Fergal O'Brien

July 30 (Bloomberg) -- Europeans' confidence in the outlook for the economy dropped the most since the Sept. 11 terrorist attacks as soaring energy costs and the euro's advance against the dollar rattled consumers and executives.

An index measuring sentiment in the euro area fell 5.3 points to 89.5 this month, the European Commission in Brussels said today. That is more than economists had forecast and the biggest slide since a 6.3-point drop in October 2001, the month after the attacks in the U.S.

Rising commodity prices have lifted euro-area inflation to a 16-year high of 4 percent, sapping consumers' purchasing power and pushing up companies' costs. That is adding to pressure on the economy as the global turmoil in credit markets restricts access to capital, which may limit the European Central Bank's scope to increase interest rates to fight inflation.

This is the ``latest number in a string of very weak data that confirm that the economy is experiencing a severe downturn,'' Aurelio Maccario, chief euro-area economist at Unicredit MIB in Milan, said in an e-mailed note. ``The economy is heading toward a stagnation phase bound to last at best a few months.''

Economists had forecast that the confidence index would drop to 93, according to the median of 30 estimates in a Bloomberg News survey. A separate report today showed retail sales declined for a second month in July.

Euro, Bonds

The euro erased its gains after the sentiment report. The currency was little changed at $1.5588 as of 12:45 p.m. in London, having earlier been as high as $1.5617. Bonds rose, with the yield on the German bund, Europe's benchmark security, falling 4 basis points to 4.43 percent.

Reports this month showed that euro-area manufacturing and service industries contracted in July by the most since 2003. Consumer confidence in Germany and France, the region's largest economies, fell more than economists had forecast.

The Frankfurt-based ECB this month raised its key rate by a quarter point to 4.25 percent to curb price increases even as economic growth slows. The central bank in June forecast that euro-area expansion will ease to about 1.5 percent next year from 1.8 percent this year, after growth of 2.7 percent in 2007.

Today's report shows the ECB's task may become more difficult. A measure of companies' selling-price expectations rose to 20 in July from 16 in June, compared with an average reading of 6 over the last 18 years. Consumers' outlook for prices remained close to a seven-year high, the report showed.

`Significant Degree'

``This may tie the hands of the ECB to a significant degree,'' said Gareth Claase, an economist at Royal Bank of Scotland Plc in London. ``Given that in June the central bank showed willingness to hike into a slowdown we are reluctant to forecast rate cuts.''

Companies are feeling the pressure of a 59 percent increase in crude oil in the past year, which has boosted their energy costs, as well as higher prices for commodities including wheat and corn. Confidence within the manufacturing, construction, services and retail industries all declined this month, according to the survey. Consumer sentiment dropped to minus 20, the lowest in five years.

Ryanair Holdings Plc, Europe's biggest discount airline, this week said it may post its first full-year loss since going public in 1997 because of increased fuel expenses. British Airways Plc started talks to merge with Spain's Iberia Lineas Aereas de Espana SA to lower expenses as slower economies and higher energy costs erode earnings.

Rising Costs

As euro-area companies grapple with rising costs, they also are contending with the euro's 15 percent advance against the dollar in the past 12 months. European Aeronautic, Defence & Space Co., the world's biggest maker of airliners, today raised its target for spending cuts by almost 50 percent as the weaker dollar reduces profit converted into euros.

Some companies are coping. SAP AG, the world's biggest maker of business-management software, yesterday raised its revenue and margin forecasts for this year and said its pipeline is ``strong'' in the U.S.

Still, data suggest further weakness ahead. Manufacturers' new orders fell for a fourth month in July, according to a monthly survey of purchasing managers published July 24. New business among services companies dropped for a second month. Infineon Technologies AG, Europe's second-biggest semiconductor maker, on July 25 said it plans to cut about 3,000 jobs after its third-quarter loss tripled.

``The business and consumer surveys have stagflation written all over them,'' said Martin van Vliet, an economist at ING Group in Amsterdam. There is a ``frightening mix of sharply falling confidence and elevated inflation expectations.''

To contact the reporter on this story: Fergal O'Brien in Dublin at fobrien@bloomberg.net.