Factory downturn takes root in heart of euro zone

LONDON Fri Jun 1, 2012 6:39am EDT

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LONDON (Reuters) - The euro zone's manufacturing sector contracted at its steepest pace in nearly three years in May as the debt crisis batters confidence and new orders continued to dry up, a business survey showed on Friday.

A downturn that began in the region's periphery is becoming entrenched in the bloc's biggest economies like Germany and France, the survey showed, suggesting the sector - which drove a large part of the recovery from the last recession - will drag on growth.

Markit's Eurozone Manufacturing Purchasing Managers' Index (PMI) dropped to 45.1 in May from 45.9 in April, slightly above a preliminary reading but marking its lowest reading since June 2009.

It has been below the 50 mark that divides growth from contraction for ten months and similarly the output index fell to 44.6 from April's 46.1, also the lowest since June 2009.

"The data suggest that the sector is contracting at a quarterly rate of around 1 percent, suggesting that manufacturing will act as a major drag on economic growth in the second quarter," said Chris Williamson, chief economist at data provider Markit.

"All four of the largest euro zone nations are now reporting worryingly sharp downturns in their manufacturing sectors."

Earlier data from Germany, Europe's largest economy and whose strength prevented the euro zone falling into recession in the first quarter, and France showed their manufacturing sectors contracted at the fastest pace in nearly three years.

Italy's factories contracted for the tenth straight month while in Spain the PMI fell below that of Greece's and posted the lowest reading of all the countries surveyed.

"Euro zone manufacturers reported a deepening downturn in May, indicating that the damage to the real economy caused by the region's financial and political crises continues to spread across the region."

Greece, long the center of the financial maelstrom that has ravaged the bloc, is due to return to the ballot box in three weeks for a crucial second election that may determine whether it remains a member of the currency union.

Its euro membership will hinge on whether voters create a government that rejects or accepts severe austerity as the price for receiving hundreds of billions of euros in EU bailout funds, on which the state now depends.

Recent Reuters polls of fund managers, economists, and money market traders have all suggested that battered Greece will still be a member of the 17-nation bloc come 2014.

ORDER FALL

As the downturn deepened firms cut staffing levels for the fourth straight month as they struggle to contain costs as they face decimated order books.

New orders dwindled for the twelfth straight month in May with the sub-index falling to a six-month low of 42.6 from April's 43.5 as export orders continued to sink.

The fall comes despite firms cutting margins by only nudging up prices in the face of more rapidly rising input costs.

Inflation in the euro zone eased by more than expected to its lowest level in more than a year in May, giving the European Central Bank a little more room to lower interest rates to help revive economic growth across the continent, official data showed on Thursday.

Growing signs the euro zone economy is deteriorating and inflation easing prompted more than a third of economists polled by Reuters this week - 27 out of 73 - to say the ECB will cut interest rates before the end of the year to boost growth. <ECB/INT>

The central bank is expected to cut its growth forecasts for this year and next when it meets next week.

(Editing by Toby Chopra)

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