European Services, Manufacturing Contracted in August

By Ben Sills

Aug. 21 (Bloomberg) -- Europe's manufacturing and service industries contracted for a third month in August as consumers and businesses reeled from July's record oil prices.

Royal Bank of Scotland Group Plc's composite index was at 48 after 47.8 in July, Reuters Plc reported. Economists forecast a decline to 47.7, the median of 18 estimates in a Bloomberg News survey shows. The index is based on a survey of purchasing managers by Markit Economics in London and a reading below 50 indicates contraction.

While oil prices have fallen 20 percent from a record $147.27 a barrel on July 11 and the euro has dropped 7 percent from its peak, their gains over the past year have damped economic growth. The economy of the 15 nations using the euro shrank in the second quarter after faster inflation curbed spending power and the currency's strength as well as the U.S. subprime mortgage crisis hurt demand for European exports.

``There are simply too many headwinds,'' said Martin Van Vliet, an economist at ING Bank in Amsterdam. ``There remains a risk that the region's economy will contract in the third quarter.''

Gross domestic product fell 0.2 percent in the second quarter from the first, when it grew 0.7 percent, the European Union's statistics office said last week. The European Central Bank, which raised its benchmark rate by a quarter point to 4.25 percent in July, currently predicts growth will slow to about 1.8 percent this year from 2.7 percent in 2007.

Rate Cuts Approaching?

Markit's manufacturing index was at 47.5 after 47.4 in July while the services index declined to 48.2 from 48.3.

``The figures confirm that the ECB's growth projections are no longer realistic and the time for rate cuts is approaching,'' Christoph Weil, an economist at Commerzbank AG in Frankfurt, wrote in a research note to clients today. ``Disappointing economic news has still not brought down inflation expectations, though, and only when this happens will the ECB be willing to cut interest rates. We do not expect this to be the case until next year.''

Inflation is currently running at 4 percent, a 16-year high, and expectations, as measured by the breakeven rate on five-year French inflation-indexed bonds, rose to 2.22 percent today. The central bank aims to keep inflation just below 2 percent.

ECB council member Nout Wellink told Dutch newspaper Het Financieele Dagblad that the damping effect of lower oil prices on inflation is ``much reduced'' by the euro's decline.

Euro, Oil Decline

The currency's drop to $1.4780 today from a record $1.6038 on July 15 may support economic growth by easing pressure on companies' margins. German investor confidence rose more than forecast in August after touching a record low in July.

``The decline in oil prices and the euro are helping to lessen concerns about where the euro zone economy might be in six months' time,'' said Matthew Sharratt, an economist at Bank of America in London.

Even as the U.S., the world's biggest economy, skirts a recession, demand from emerging markets in Asia and Latin America has helped to support European export sales. Schneider Electric SA, the Paris-based maker of circuit breakers, reported a 17 percent advance in first-half profit this month and raised its forecast for 2008 sales on demand in China.

``No sign of change in our emerging markets but there's some slowdown in traditional construction in North America and Europe,'' Chief Executive Officer Jean-Pascal Tricoire said on Aug. 1.

`Appreciable Mark'

Bayerische Motoren Werke AG, the world's largest maker of luxury cars, on Aug. 1 abandoned its 2008 profit forecast, citing the higher cost of commodities and the decline in the value of its dollar sales. Allianz SE, Axa SA and Aegon NV, three of Europe's biggest insurers, all reported lower profit this month as the subprime contagion eroded the value of their holdings.

``The protracted difficult climate on international capital markets and movements in exchange rates did leave an appreciable mark on our results,'' Wilhelm Zeller, Chief Executive Officer of Hannover Re, Germany's second-biggest reinsurer, said Aug. 7 after announcing a 40 percent decline in second-quarter profit.

European banks have suffered $228 billion of losses since last year from investments in the U.S. mortgage market. The median house price in the U.S. fell 7.6 percent in the second quarter from a year earlier, the National Association of Realtors said this month.

To contact the reporter on this story: Ben Sills in Madrid at bsills@bloomberg.net