Aug. 27 (Bloomberg) -- Loans to households and companies in Europe grew at the slowest pace on record in July, suggesting the economy may struggle to recover from its worst recession since World War II.

Loans to the private sector rose 0.6 percent from a year earlier, the slowest growth since records began in 1991, after increasing an annual 1.5 percent in June, the European Central Bank said today. On the month, loans fell 0.4 percent, the biggest decline ever recorded.

The global recession has made banks reluctant to lend and also eroded demand for debt. While the German and French economies unexpectedly resumed expansion in the second quarter, growth is likely to remain muted unless credit flows improve and companies and households increase spending. The ECB has cut its benchmark interest rate to a record low of 1 percent and is flooding banks with cash in an effort to revive lending.

Today’s data “provide little sign that the ECB’s continued provision of liquidity to banks has prompted them to increase their lending to the wider economy,” said Ben May, an economist at Capital Economics Ltd in London. “Although prospects for the economy are improving, investment looks set to remain weak.”

European banks tightened credit standards for companies and households in the second quarter, albeit less aggressively than in the first, according to a survey published by the ECB on July 29. Policy makers have urged banks to clean up their balance sheets and step up lending after the collapse of Lehman Brothers Holdings Inc. last year exacerbated the global slump.

‘A Long Haul’

M3 money-supply growth, which the ECB uses as a gauge of future inflation, slowed to 3 percent in July from 3.6 percent in June. That’s the slowest since July 1995. M3 is the broadest gauge of money supply and includes cash in circulation, some forms of savings and money-market holdings.

“The ECB is likely to interpret today’s data as signaling that the profound nature of the financial crisis means that, from a monetary-policy perspective, we are still in for a long haul,” said Julian Callow, chief European economist at Barclays Capital in London. “Monetary policy, including the full panoply of non-standard operations, will need to remain highly accommodative for a substantial period of time.”

There are signs that the economy of the 16 nations sharing the euro, which shrank 0.1 percent in the second quarter, has resumed growth. The contraction in the region’s services and manufacturing industries slowed this month and economic confidence rose to an eight-month high in July.

M1 Growth Surge

M1, which captures the most liquid form of money in the economy such as cash and overnight deposits, grew 12.2 percent in July from a year earlier, the ECB said today. Accelerating M1 growth indicates more money is available for spending and investment which, when enacted, spur economic growth.

Still, euro-region retail sales fell for a 15th month in August, the Bloomberg purchasing managers index showed today.

“Today’s monetary numbers illustrate how fragile the ongoing recovery still is,” said Carsten Brzeski senior economist at ING Group in Brussels. “A strong slowdown in credit growth is more than normal when the economy is in the middle of a severe recession, but the credit cycle needs to follow improved sentiment soon to get the recovery really going.”

To contact the reporter on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net.

Last Updated: August 27, 2009 05:52 EDT