GLOBAL ECONOMY-Services contract in US, fading fast in euro zone

By Ross Finley

LONDON, Feb 5 (Reuters) - The world economy shuddered at the start of the year, with markets rocked by reports on Tuesday suggesting the vast U.S. services sector unexpectedly contracted to recessionary levels and the euro zone's was barely growing.

News that an index measuring services business in the world's largest economy fell off a precipice last month, swinging from modest growth to contraction, shook bank trading desks and triggered a sell-off on an already battered Wall Street.

The Federal Reserve, which has already slashed interest rates by 1.25 percentage point over the past few weeks, looks set to deliver more and the pressure on the European Central Bank to cut borrowing costs is whistling at full blast.

The Institute for Supply Management said its key non-manufacturing services index plunged to 41.9 in January from 54.4 in December, more than 10 points below the Reuters consensus for 53.0 and taking analysts totally by surprise.

This was the lowest since October 2001, after the Sept. 11 attacks that destroyed the World Trade Center in New York and when the U.S. slipped into a mild recession.

"An absolutely stunning ISM non-manufacturing number leaves the chart of the index looking like it has fallen off the edge of a cliff, and is heartwarming only for those who think the economy is already in a recession," said Alan Ruskin, strategist at RBS Greenwich.

But analysts cautioned that the short history of the index -- it has only been published since July 1997 and so has not actually measured a deep recession -- was reason to expect that perhaps some of the weakness was overstated.

"It seems clear that the economy has slowed in recent months: however, we will need to see much more in the way of supporting evidence before we believe that growth has slowed as much as this series suggests," said Drew Matus, economist at Lehman Brothers in New York.

ISM said the data, which are based on a survey of 370 purchasing managers in the services sector, were published ahead of the normal 1500 GMT release time and ahead of the Wall Street stock market open because of concerns that the data may inadvertently have been released late on Monday.

The data followed news earlier on Tuesday that euro zone services growth slowed to a near halt in January from an already weak early estimate, with services in three of the bloc's four biggest economies -- Germany, Italy and Spain -- contracting.

Of the big four only France showed growth.

The RBS/NTC Euro zone Services Purchasing Managers Index fell a sharp 1.4 points to 50.6 in January from an earlier flash estimate of 52.0. That index is now dangerously close to the 50 mark that divides growth from contraction.

Those data marked a new four-and-a-half year low for services in the 15-member bloc and also came in well below the 52.0 consensus -- although by nowhere near a big a gap as the U.S. numbers.

"Euro zone growth is in trouble and the risk of recession at some stage should not be underplayed. Business confidence is sliding and consumer morale is being hit hard," said David Brown, chief European economist at Bear Stearns, before the U.S. ISM report was released.

A Reuters poll last week found economists bringing forward the expected timing of an ECB interest rate cut from the current 4 percent to the second quarter from the second half, with a second cut anticipated by year-end [ECI/INT].

But all 83 economists polled expected no change when the ECB meets on Thursday.

"In the short term I don't think it will change their assessment: the doves will highlight the downside risks to growth and the hawks will find munitions to say we are still in the process of strong inflationary pressure," Gilles Moec, an economist at Bank of America in London, said of the ECB.

The dollar pared earlier gains against the yen JPY= and the euro EUR= after the U.S. services report, while interest rate futures and government bonds in the U.S. and Europe soared. The Standard & Poor's 500 index .SPX dived 2 percent and major stock markets in Europe also reeled.

Yet comparable data from CIPS/NTC showed Britain's service sector held up in January and growth in prices charged rose for the sixth straight month to near their highest on record.

In the euro zone, growth in prices charged held up, and followed official data last week that showed euro zone inflation hit a record high of 3.2 percent in January.

So far inflation worries have held the ECB from cutting interest rates. But most analysts say it is only a matter of time before they do.

Bear Stearns' Brown pointed out that the last time euro zone inflation was this high, it didn't prevent the ECB from cutting rates. Although back then it was too late, he said.

"The consequence of delaying so long then was two consecutive German recessions in 2002 and 2004," he said.

FOR FULL SERVICES PMI DATA.................<PMI/EUSA>

FOR GUIDE TO ALL PMI INDICES.............<PMI/INDEX1>

(Editing by Ruth Pitchford)