Euro Zone Service Sector Rebounds; Spain, Italy Lagging

Euro zone services growth staged a partial comeback in February, in line with an earlier estimate, though a sharp divide in growth rates within the bloc poses a problem for the European Central Bank.

The RBS/NTC Eurozone Purchasing Managers Index for the services sector, covering companies ranging from insurance brokers to hotels, was confirmed at 52.3 in February. That was up from a four and a half year low of 50.6 in January, and in line with the flash reading and economists' forecasts.

The rebound offers some support to the ECB's stance of resisting calls for interest rate cuts at a time when many leading economic indicators point to slower growth in the euro zone.

Yet policymakers will also be concerned that the PMIs revealed a significant divergence among the region's four leading economies.

Germany bounced back from contraction in the first month of the year to 52.2 from 49.2, beating all expectations in a Reuters poll for a smaller rise to 50.9, while France headed into even more robust territory at 58.2 from 56.6.

In stark contrast, Spain and Italy remained below the 50.0 mark that separates growth from contraction for the third and second consecutive month, respectively. Italy's services PMI fell to its lowest level in the survey's 10-year history.

"It's the same as we saw for the manufacturing PMI -- there is a division between Germany and France on the one hand where the economic slowdown is still moderate, whereas Spain and Italy are in a bigger crisis," said Monika Wohlmann at WestLB.

Indeed, Spain showed signs of stagflation -- stagnant growth with rising inflation. Its service sector shrank and business confidence hit a record low, while input cost inflation rose to a seven-year high.

"That will pose a challenge for the ECB to find an interest rate policy that is appropriate for all countries in the euro zone," added Wohlmann.

Financial markets shrugged off the data.

But an overall rebound in the services index helped push the Composite Index, which includes the Manufacturing PMI, up to 52.8 from 51.8 in January.

Service companies' costs also remain at stubbornly high levels as energy and food prices soar, though they did ease in February away from November's seven-year peak.

Inflationary pressures will make it difficult for the ECB to cut interest rates in coming months. Official inflation in February held at record highs of 3.2 percent, well above the ECB's target of at or just below 2.0 percent.

But economists still expect the bank to cut rates twice by 25 basis points this year, with the first move coming by June as it acknowledges weaker growth.

Indeed, there are signs in the services survey of easing growth to come. The business expectations index slipped close to a five-year low at 60.2, down from 61.5 in January, and the 60.7 recorded for the flash reading.

On the flipside, incoming new business bounced back in February to 52.2 from 49.8, just slightly down on the 52.3 flash estimate. The pace of hiring also picked up to 54.3 from 54.1 in the first month of the year, just down on the 54.4 flash.

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