Euro-Area Manufacturing, Services Shrink as Crisis Worsens

European companies are cutting back on hiring and spending as the intensifying fiscal crisis makes the economic outlook more uncertain. While the 17-nation euro area narrowly avoided falling into a recession in the first quarter, unemployment has reached the highest on record and economic confidence is at the lowest since 2009.

The data point “to markedly contracting activity and further weakness ahead,” said Howard Archer, chief European economist at IHS Global Insight in London. “It is odds-on that the euro zone is headed for renewed and appreciable contraction in the second quarter.”

The euro extended declines against the dollar after the data and traded at $1.2420 at 11:04 a.m. in Brussels, down 0.6 percent on the day and near a two-year low.
European Funds

Investors are growing more concerned about the debt crisis after inconclusive Greek elections raised the prospect of a breakup of the single currency and as Spain struggles to recapitalize its banking system. Spanish Budget Minister Cristobal Montorotoday called for European funds to be used to shore up the nation’s banks.

Finance ministers and central bank governors from the Group of Seven hold a call today to discuss the debt crisis. The G-7 discussions precede a summit of leaders from the Group of 20 on June 18-19 in Los Cabos, Mexico.

The fiscal crisis is clouding the outlook for economies and companies from Portugal to Germany. Bayerische Motoren Werke AG, the world’s biggest maker of luxury vehicles, predicted on June 1 that the German car market won’t grow in 2012 as the debt turmoil weighs on consumer spending.

“Companies report business activity to have been hit by heightened political and economic uncertainty, which has exacerbated already weak demand both in the euro area and further afield,” Chris Williamson, chief economist at Markit, said in today’s report. “Based on these numbers, it would not be surprising to see GDP for the region contract by 0.5 percent in the second quarter.”
Largest Economy

The European Commission said last month that the euro-area economy may shrink 0.3 percent this year, with countries from Spain to the Netherlands in recessions. In Germany, Europe’s largest economy, gross domestic product may rise 0.7 percent, the Brussels-based commission projected.

The European Central Bank will release its latest economic projections for this year and next when council members meet in Frankfurt tomorrow. ECB President Mario Draghi will also announce whether the central bank will continue to lend banks unlimited liquidity at its benchmark rate, currently at a record low of 1 percent.

Today’s data “intensifies the pressure on the ECB to cut interest rates further, and sooner rather than later,” IHS’s Archer said. “We doubt that the ECB will cut interest rates as soon as Wednesday — although it is not inconceivable given the euro zone’s heightened economic and sovereign-debt problems – but we do now think it is highly likely that the ECB will cut interest rates to 0.75 percent in the third quarter.”

An index of euro-area services activity declined to 46.7 in May from 46.9 in the prior month, while a gauge of euro-area manufacturing decreased to 45.0 from 45.9 in April, according to Markit.