Euro Zone, UK Service Sectors Stumble but Optimisic

Signs of a recovery in the euro zone's dominant services economy took a backwards step in June but business optimism hit a near two-year high on hopes that the worst is over, surveys showed on Friday.

Markit revised up its Eurozone Services Purchasing Managers Index in June to 44.7 from the flash estimate of 44.5, but this was down from May's 7-month high of 44.8.

Economists had expected 44.5 and this marks the 13th consecutive month the index has been below the 50 mark that divides growth from contraction.

"They are grinding slowly higher but we are still short of the 50 mark which suggests that as we approach the half-way stage of 2009 that the economy isn't growing yet and it is going to take a few months before we get back above the gain line," said Peter Dixon at Commerzbank.

The euro was unmoved by the data.

There was evidence of divergence in the big four economies in the region.

Earlier data showed activity in Germany's services sector fell at the same pace as in May, while in France and Spain the sector shrank at a slower pace. The rate of contraction accelerated in Italy.

However, firms ranging from banks to restaurants were optimistic and the business expectations index rose to 62.3 from May's 59.1, a level not seen since July 2007.

Data from Britain showed its dominant services sector expanded for a second month in June but the pace of recovery slowed as new business contracted.

The euro zone economy shrank a record 2.5 percent quarter-on-quarter in the first three months of this year.

But it is expected to contract much less severely in the second quarter, with a return to growth pencilled in for the last three months of this year.

The European Central Bank left interest rates at 1.0 percent on Thursday, and the market sees them staying there until October next year at least as the ECB battles to boost the flagging economy.

Composite Continues Climbing

The euro zone composite index, which includes manufacturing data released on Wednesday, rose to a 9-month high of 44.6 last month, revised up from the flash estimate of 44.4 and above May's 44.0. Economists had forecast 44.4.

"The final composite PMI for June showed that the rate of contraction has eased substantially since February's peak, but the rise in the Output Index was disappointing compared to improvements seen in previous months, and the Index has still yet to regain its pre-Lehman level," Chris Williamson at Markit said.

The composite employment index rose to a 5-month high of 42.2, up from May's 40.7, but showed that firms are still slashing jobs in an effort to cut costs and stay afloat.

Meanwhile, the composite output price index remained solidly sub-50, suggesting firms are having to slash prices to woo customers.

Official euro zone inflation fell 0.1 percent in June, the first time prices have dipped into the negative territory in the bloc, and economists expect it to fall further over the summer months before climbing in the later stages of the year.

Recovery in UK Services Sector Slows in June

Britain's dominant services sector expanded for a second month in June but the pace of recovery slowed as new business contracted and firms stepped up the pace of job cuts, a monthly survey showed on Friday.

The headline PMI index eased to 51.6 from 51.7, confounding expectations for an improvement to 52.0.

Last month's leap above the 50-mark that denotes growth raised hopes that Britain may be one of the first major economies to emerge from recession.

While a pause in momentum may not be a huge setback given the pace of improvement in recent months, it will play into policymakers' fears that a sustained recovery is far from assured.

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"The sideways movement in the headline business activity index in part reflects some consolidation," said Paul Smith, senior economist at Markit. "Nonetheless, the underlying data indicate that the business climate remains fragile with tight lending conditions and rising unemployment remaining key threats to continued service sector recovery."

The Bank of England meets to discuss monetary policy next week but markets do not expect any rise in interest rates until the end of the year at the earliest. Neither does the Bank appear in any rush to reverse its policy of pumping money into the economy to boost demand.

Indeed, the current debate is whether the Bank will raise its target for quantitative easing with many economists expecting an increase to 150 billion pounds to be announced as early as next week.

Fragile Recovery

Britain's economy shrank at its fastest pace in more than 50 years in the first three months of this year but better data in recent months has generated hope of a return to growth in either the second or third quarters of this year.

Nevertheless, economists have also cautioned that much of the recent pick-up in activity could be due to re-stocking after firms ran down inventories last year.

Heightening such concerns, the new business index fell to 49.7 in June from 51.8 in May — the first decline in the index since November.

"Anecdotal evidence from the survey panel indicated that economic conditions remained difficult overall, with clients reluctant to commit to expenditure given ongoing uncertainty," the survey noted.

In a bid to support sales, average output prices were cut for an eighth consecutive month in June. In contrast, average input prices picked up slightly on the back of higher fuel costs.

Despite the fall in new business and further job losses, business confidence continued to rise in June with the expectations index hitting its highest level in almost two years.

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