Europe Services Growth Accelerated More Than Forecast (Update3)

By Sandrine Rastello


Feb. 22 (Bloomberg) -- Growth in Europe's service industries accelerated more than economists forecast in February, prompting investors to reduce bets on European Central Bank interest-rate cuts. The euro climbed after the report.

A preliminary estimate of Royal Bank of Scotland Group Plc's services index rose to 52.3 from 50.6 in January. Economists expected a reading of 51, according to the median of 38 forecasts in a Bloomberg News survey.

Evidence that economic growth in Europe is holding up reduces the need for the ECB to follow counterparts in the U.S. and U.K. in lowering borrowing costs. While the European Commission yesterday cut its forecast for the euro region's 2008 expansion to 1.8 percent, the weakest since 2005, it predicted accelerating inflation.

``The euro area is likely to prove fairly resilient to headwinds,'' Klaus Baader, Merrill Lynch & Co.'s London-based chief European economist, said in a Bloomberg Television interview. ``If we continue to see that kind of data, markets will reconsider their expectations'' for ECB interest rates.

The euro rose to $1.4834 at 1:08 p.m. in Paris from as low as $1.4789 before the report. Yields on interest-rate futures pared their decline.

Faster Inflation

Investors had increased bets on a cut in Europe after ECB President Jean-Claude Trichet on Feb. 7 withdrew a threat to raise rates and expressed concern that the outlook for growth had deteriorated. The yield on interest-rate contracts maturing in December fell as low as 3.31 percent on Feb. 11 from 4.18 percent at the start of the year. It was at 3.62 percent today.

The ECB has held off lowering interest rates as inflation accelerated to a 14-year high of 3.2 percent in January, above the bank's 2 percent limit for a fifth month. The U.S. Federal Reserve cut its main rate by 1.25 percentage points last month, and the Bank of England reduced its benchmark by a quarter point on Feb. 7 for the second time in three months.

Trichet has signaled he's in no rush to act. On Feb. 14, he said central bankers in the U.S. and U.K. based their decisions on a ``very different'' economic outlook.

The ECB ``is going to push back a rate cut as long as it can,'' said Sylvain Broyer, an economist at Natixis in Frankfurt.

Composite Index Rises

The U.S. slowdown, which economists at Goldman Sachs Group Inc. and Morgan Stanley already call a recession, has yet to be felt by some companies, such as Air France-KLM Group, Europe's largest airline. The company on Feb. 14 reported a measure of fiscal third-quarter profit that exceeded analysts' estimates and stuck to a margin forecast for the year as it attracted more passengers and raised prices.

Royal Bank's composite purchasing managers' index, which combines services and manufacturing and accounts for about half of the economy, rose to 52.7 from 51.8. A gauge of manufacturing slipped to 52.3 from 52.8, in line with economists' forecasts.

Higher energy prices and more expensive food are fanning inflation, which the European Commission says will average 2.6 percent this year, up from a November estimate of 2.1 percent. At the same time, the U.S. slowdown is combining with costlier credit, oil prices at about $100 a barrel and a stronger euro to curb expansion, the commission said.

``The risks to the growth outlook are mainly on the downside,'' European Union Monetary Affairs Commissioner Joaquin Almunia told reporters in Brussels yesterday.

Temporary Rebound?

The rebound in services is probably temporary after several months of decline, said David Brown, chief European economist at Bear Stearns Cos. in London.

Euro-zone economic confidence has been in ``decline since the middle of 2006,'' Brown wrote in a note to investors. ``This looks set to extend as we are nowhere near reaching a bottom yet.''

A gauge of business expectations in service industries fell to 60.7 from 61.5 in January, today's report showed. Growth in new manufacturing orders slowed, with a measure slipping to 51 from 51.7 last month.