Sept. 21 (Bloomberg) -- Europe's manufacturing and service industries grew this month at the weakest pace since 2005 after a sudden increase in credit costs hurt banks.

The slowdown 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 already threaten to damp economic growth.

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. The gauge of services which account for about a third of the economy, had its biggest decline since it was compiled in 1998, after the collapse of the U.S. subprime mortgage market.

``The services side has held up better up to now, and it's worrying if that is about to change,'' said Sandra Petcov, an economist at Lehman Brothers Holdings Inc. in London. ``We had already expected to see investment cool, as the past interest rate increases start to feed through. And on top of that you have this hit'' from the financial-market turmoil.

The manufacturing index declined to 53.2 from 54.3, while the 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. A level above 50 indicates growth.

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.

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 4.26 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.

Fed Cut

``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 Stockbrokers 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.

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 against the dollar this year, hurting European competitiveness, and was at $1.4082 as of 4:21 p.m. in Paris.

EADS Costs

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

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.

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.

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

Last Updated: September 21, 2007 11:41 EDT