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Euro Zone August Growth Dips, Confidence Hit

Euro zone private sector growth cooled in August as factory order growth hit its weakest since late 2005 and a credit squeeze in financial markets bruised service sector confidence, key data showed on Friday.

The hit to sentiment was the biggest since October 2002, in the run-up to the U.S.-led Iraq War, and brought expectations to their weakest since March 2003, during the Iraq invasion, in a survey conducted mainly during recent market turmoil.

While the RBS/NTC Economics flash PMIs suggested only a mild slowdown for now, the souring in sentiment as stocks and currencies gyrated and lending between banks jammed up in August suggests activity may cool off somewhat in September.

"The important thing to bear in mind is that the PMI data have already been trending down for about a year now, and that the downtrend does not seem to have accelerated with the latest turbulence in financial markets," said Sandra Petcov, euro area economist at Lehman Brothers.

Services activity held up, as did growth in prices charged. The flash services PMI slipped to 57.9 in August from 58.3 but was only a bit below expectations for 58.0 and just below one-year highs marked in the prior two months.

The 50.0 mark divides growth and contraction.

Economy Still Growing Strongly

The flash manufacturing PMI fell to 54.2 from 54.9, below the 54.5 economists had expected and the weakest since January 2006. New orders growth fell to its weakest since November 2005.

The flash composite PMI slipped only modestly to 57.2 from 57.5, suggesting the economy is still growing strongly although clearly on a slowing trend.

"To the extent that expectations become seriously gloomy, enough to affect firms' decisions about production, investment and hiring, this warrants keeping an eye on," said Petcov.

Company evidence has also yet to show worrying signs. The latest earnings season in Europe was far from disappointing and only turmoil in the credit markets hauled stock markets off of their bullish march upward.

Financial markets did not react to the data.

Pause with Rates?

The European Central Bank signalled this week it is still inclined to raise rates to 4.25 % in September but much will depend on how quickly the logjam in credit markets breaks.

That market turmoil has already triggered a 50 basis point cut in the U.S. discount window rate for emergency loans and plenty of speculation of a cut in the federal funds policy rate by the Fed's September 18 meeting.

"If you were looking at those numbers without what is happening in terms of financial conditions and the financial market adjustments, you would feel very comfortable to raise rates," said Jacques Cailloux, chief euro area economist at RBS, which sponsors the survey. "(But) we know that confidence has been hit hard."

The data suggested the euro zone economy is still growing strongly, despite official data earlier this month that showed the bloc grew by only 0.3% in the second quarter, half the rate in the first three months of the year.

While August growth in new orders for services business declined, it was not by much and hiring still remains robust.

"The survey continues to point to a rebound in GDP growth in the second half of this year. This therefore supports our view that the ECB will still hike interest rates in September, provided market conditions continue to improve," said Jennifer McKeown at Capital Economics.

But the picture was different for manufacturing, which was booming a year ago and is now on a cooling trend.

Most indicators pointed to a easing in activity, from hiring to the backlogs of work, which hit its lowest level since September 2005. NTC said that the August data suggested capacity constraints in manufacturing may be easing.

The bulk of the survey was conducted during the week of August 13 and the current week, NTC said.

Contact Europe: Economy

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