European Manufacturing, Services Growth Slows (Update3)

By Fergal O'Brien

Sept. 21 (Bloomberg) -- Europe's manufacturing and service industries grew at the slowest pace in two years this month after a sudden increase in credit costs hurt banks, adding to evidence that economic growth is waning.

Royal Bank of Scotland Group Plc said today a preliminary estimate of its composite index fell to 54.5 in September from 57.4 in August. That's the lowest since September 2005 and below the 56.9 median of 15 forecasts in a Bloomberg News survey. A reading above 50 indicates growth.

The drop in the index may spell the end of almost two years of interest-rate increases by the European Central Bank. Gains in oil prices and the euro's increase to a record $1.412 already threaten to damp growth. The index of services, which account for about a third of the economy, had its biggest decline since the gauge was compiled in 1998, after the U.S. mortgage market collapse curtailed bank lending.

It is the ``plunge in the services equivalent that raises a big question mark on the eurozone,'' said Aurelio Maccario, an economist at Unicredit MIB in Milan. There's ``no room for the ECB to keep on tightening.''

The manufacturing index declined to 53.2 from 54.3, while a gauge of services dropped to 54 from 58. Both numbers were lower than economists forecast. A reading of manufacturing orders dropped to 52.4 from 54.8 and the services' measure of new business also declined.

Impact on Banks

Commerzbank AG, Germany's second-biggest bank, said yesterday that second-half earnings will be weaker than in the first six months ``due to market conditions,'' retreating from a forecast that it would beat its target. Deutsche Bank AG said it will write down the value of leveraged loans and scale back hiring plans after making ``mistakes'' during the credit boom that ground to a halt in the past two months.

``While the crisis persists, monetary conditions are unlikely to ease of their own accord and the euro-zone economy will suffer accordingly,'' said Dermot O'Brien, chief economist at NCB Stocbrokers in Dublin. ``Our expectation is that the ECB will be cutting rates early in 2008 if not sooner.''

Royal Bank of Scotland economists today said they now expect the ECB to cut interest rates next year, having previously anticipated the Frankfurt-based central bank would keep its benchmark on hold.

Fed Cut

The U.S. Federal Reserve cut its benchmark rate by half a percentage point this week, saying tightening credit has the potential to ``intensify the housing correction, and to restrain economic growth more generally.''

The ripple effects of the housing slump add to risks to Europe's economy. Crude oil futures rose to $82.51 on Sept. 19, the highest since trading began in 1983. Prices are up 35 percent from a year ago. The euro has risen 6.6 percent this year, hurting European competitiveness.

Confidence among consumers and business dropped to a six- month low last month, according to an Aug. 31 report.

The ECB cut its growth estimate for the euro area to 2.5 percent from 2.6 percent, joining the European Commission and the International Monetary Fund in becoming more pessimistic. The economy grew 2.8 percent last year, the fastest since 2000.

European Aeronautic, Defence & Space Co.'s Airbus SAS unit faces extra costs of 1 billion euros ($1.41 billion) for every 10-cent increase in the euro against the dollar, Chief Operating Officer Fabrice Bregier said told BFM Radio today.

Renault SA, France's second-largest carmaker, last month said its 2007 sales target was a ``difficult objective'' because of a sluggish auto market in Europe.

Futures trading shows investors have pared bets that the ECB will raise the 4 percent benchmark rate further. The implied yield on the three-month Euribor futures contract for March was at 4.27 percent today, down from 4.38 percent on Aug. 31.

The contract settles to the three-month interbank offered rate for the euro, which has averaged about 16 basis points above the ECB's benchmark rate since 1999.

Last Updated: September 21, 2007 08:03 EDT