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Stagflation gets a grip on eurozone

Latest update : 2008-06-24

The combination of a stagnant economy, a decrease in purchasing power and an overvalued oil barrel, is leaving the fifteen countries of the Eurozone in fear of stagflation. (Analysis: C.Vanier)

Business activity in the 15 euro countries contracted in June for the first time for almost five years, according to a widely watched survey on Monday, raising the spectre of stagflation.

The eurozone's purchasing managers' index (PMI), compiled by data and research group Markit, slid to 49.5 points in June, from 51.1 in May, according to an initial estimate.

The fall brought the index below the 50-point level indicating a contraction in activity for the first time since July 2003.

Meanwhile, the survey's component for the services sector fell to 49.5 points in June from 50.6 in May, hitting the lowest level since June 2003.

On the manufacturing front the PMI index was also down, to 49.1 in June from 51.6 in May, the worst reading since May 2006.

Economists said that the fact that business activity shrank spelled bad news for the broader eurozone economy in the months ahead, especially in the context of record inflation.

"The 'flash' June service sector and manufacturing purchasing managers' surveys for the eurozone make very worrying reading, showing a toxic cocktail of essentially stagnant economic activity but elevated and still rising inflation," said economist Howard Archer at consultants Global Insight.

"This very much heightens concern about the current state of the eurozone economy and its prospects," he added.

Although economic activity has been slowing in the eurozone, soaring oil and food prices lifted annual inflation in the bloc to a record 3.7 percent in May.

"More than the combination of higher currency and slower external demand, the decline in purchasing power triggered by the oil and food inflationary spike seems to be the chief factor behind the slowdown in economic activity in the eurozone," said Bank of America economist Gilles Moec.

"Obviously, European companies are getting increasingly squeezed by higher input cost originating from energy prices and low pricing power in an environment of weakening growth and households’ purchasing power being eroded," UBS economist Martin Lueck said.

Economist Jennifer McKeown at consultants Capital Economics said that although the PMI index's drop "points to the possibility of outright falls in eurozone gross domestic product," the European Central Bank was likely to remain inclined towards raising interest rates in the short term.

"Inflationary pressures and a solid outlook for the German economy will keep the ECB in hawkish mode for some months yet," she said.

"But continued evidence of a slowdown in eurozone activity should prompt significant rate cuts next year," she added.

Date created : 2008-06-24