Aug. 14 (Bloomberg) -- Europe's economy grew at the slowest pace in more than two years in the second quarter, hurt by weakness in manufacturing and construction.

The economy of the 13 nations that share the euro expanded 0.3 percent from the first quarter, when it grew 0.7 percent, the European Union's statistics office in Luxembourg said today. That was below the 0.5 percent median forecast of economists in a Bloomberg News survey. From a year earlier, growth slowed to 2.5 percent, compared with 3.1 percent in the first quarter.

The slowdown was led by a drop in construction in Germany and weaker investment in France. The euro's 7 percent gain against the dollar in the last year has eroded export competitiveness, while higher interest rates and a 42 percent surge in oil prices since mid-January have increased costs for companies and consumers. The European Commission today said second-half growth may be slower than previously forecast.

``With the full impact of the strong euro yet to be fully felt, the soft patch in the manufacturing sector will likely extend into the third quarter,'' said Martin Van Vliet, an economist at ING Bank in Amsterdam. ``Overall, today's weakish report does not significantly alter our cautiously optimistic outlook for the economy.''

Second-quarter growth was the slowest since the fourth quarter of 2004, when the economy also expanded 0.3 percent from the prior three months. The year-on-year growth was below the 2.8 percent median forecast of economists. The statistics office will publish a breakdown of the gross-domestic-product data on Sept. 3.

Germany, France

Growth in Germany, Europe's biggest economy, slowed to a weaker-than-expected 0.3 percent in the second quarter from 0.5 percent in the previous three months, the country's statistics office said today. Growth was curbed by a slowdown in construction after a first-quarter surge during the mildest winter on record.

France's economy, the second-largest in the euro area, unexpectedly slowed in the second quarter, as corporate investment failed to grow after rising 1.4 percent in the previous three months. Expansion in Italy and Spain also was slower than economists had forecast.

The euro fell after today's reports, slipping 0.2 percent to $1.3583 at 1:20 p.m. in Brussels. Bonds also declined after the European Central Bank pared the amount of money it lent to banks as emergency money-market financing to avert a potential credit crunch. The yield on the German 10-year note, Europe's benchmark, rose 2 basis points to 4.39 percent. The yield on the two-year bund was unchanged at 4.23 percent.

`Disappointing'

The figures are ``disappointing, but it's just a blip, because a construction slowdown had a significant impact,'' said Aurelio Maccario, an economist at Unicredit MIB in Milan. ``Domestic demand remains in good shape and that keeps the outlook rosy.''

The European Commission today predicted that the euro-area economy will expand 0.6 percent this quarter before growth eases to 0.5 percent in the final three months of the year. The commission presented the forecasts as ranges around a mid-point.

It predicted growth of 0.3 percent to 0.8 percent in the third quarter and 0.2 percent to 0.8 percent in the fourth, lowering the bottom end of the range for both quarters from its last forecasts in July. It projects growth of 0.2 percent to 0.9 percent in the first quarter of 2008.

The economy will probably grow 2.6 percent this year after 2.7 percent expansion last year, the fastest since 2000, according to separate commission forecasts. It will update the forecast on Sept. 11.

Manufacturing

Europe's manufacturing industries grew at the slowest pace in 17 months in July, while confidence among executives and consumers fell more than economists forecast. In contrast, services growth was the fastest in a year as unemployment fell to 6.9 percent, the lowest since data collection started in 1993.

Industrial production declined 0.1 percent in June from the previous month and was up 2.3 percent from a year earlier, according to a separate report today.

As manufacturers struggle with higher interest rates and oil prices, as well as the euro's strength, sentiment would be further eroded by any broadening of the credit squeeze prompted by U.S. subprime mortgage defaults. The ECB, the U.S. Federal Reserve and other central banks injected $290 billion into money markets on Aug. 9 and Aug. 10.

While the ECB added more money yesterday and today, it pared the amounts and said ``money-market conditions are normalizing.'' The Fed, the Bank of Japan and Australia's central bank already refrained from providing extra funds and resumed normal refinancing operations yesterday.

Subprime Crisis

The subprime crisis hasn't had ``any immediate impact'' on companies, said John Beggs, chief economist at Allied Irish Banks Plc in Dublin. ``What it might do, however, is make them feel a little less confident about investing.''

ECB President Jean-Claude Trichet on Aug. 2 signaled the central bank will lift its benchmark rate by a quarter point to 4.25 percent next month, which would be the ninth increase since late 2005. Investors have pared bets on the ECB lifting its key rate again after September, futures trading shows.

The implied rate on the three-month Euribor contract for December settlement dropped to 4.40 percent today from 4.52 percent on Aug. 8. The contracts settle to the three-month inter- bank offered rate for the euro, which has averaged 16 basis points more than the ECB's key rate since the currency's start in 1999.

To contact the reporter on this story: Fergal O'Brien in Dublin at fobrien@bloomberg.net.

Last Updated: August 14, 2007 08:02 EDT