Europe Manufacturing Shrinks, German Confidence Drops

European manufacturing and services output dropped in May, German business confidence declined and Britain’s first-quarter contraction was deeper than previously estimated as the region’s economic slump worsened.

A composite index based on a survey of purchasing managers in the services and manufacturing industries in the 17-nation euro area fell to 45.9 from 46.7 in April, London-based Markit Economics said today. Germany’s business climate index decreased to 106.9 from 109.9 in April and U.K. gross domestic product fell 0.3 percent in the first quarter instead of 0.2 percent estimated earlier, reports showed today.

Europe’s fiscal crisis worsened over the past month as inconclusive elections in Greece fueled concerns about a euro breakup as countries from Spain to Italy struggled to narrow in budget gaps. The euro slumped to the weakest since July 2010 against the dollar and data showed economies around the globe are also faltering, with China’s manufacturing seen shrinking in May and worse-than-forecast data from Japan and Taiwan.

“The euro zone is being buffeted by major headwinds, notably increased fiscal tightening in many countries and markedly rising unemployment,” said Howard Archer, chief European economist at IHS Global Insight in London. “The heightened Greek crisis is magnifying the problems by weighing down on already weak and fragile business and consumer confidence, adding to uncertainty about the outlook.”

35 Months

The euro dropped for a third day against the dollar, trading at $1.2583 at 12:20 p.m. in Brussels. The common currency has declined 4.6 percent over the past month.

Economists had forecast the composite indicator to drop to 46.6, the median of 14 estimates in a Bloomberg News survey showed. A gauge of euro-area manufacturing decreased to 45 in May from 45.9 in April, the lowest in 35 months, Markit said. A measure of services declined to 46.5 from 46.9; that’s the weakest in seven months, according to the statement. A reading below 50 indicates contraction.

Euro-area GDP “will almost certainly show a contraction in the second quarter,” said Martin van Vliet, an economist at ING Groep NV (INGA) in Amsterdam. “Our base scenario is still for a gradual return to modestly positive growth in the second half of the year, but with the escalating debt crisis and the ongoing drag from fiscal policy, the risks are clearly skewed to a more protracted downturn.”

The U.K.’s quarterly GDP decline compared with the 0.2 percent drop that was the median forecast of 29 economists in a Bloomberg survey. From a year ago, the economy contracted 0.1 percent, the first annual drop since the fourth quarter of 2009.

Brussels Summit

European leaders meeting in Brussels yesterday clashed over joint debt sales as they called on Greece to stick with the budget cuts needed to stay in the euro area and offered no immediate relief for recession-wracked Spain. Greece is preparing for new elections on June 17 after an anti-bailout party surged to second place in balloting on May 6.

The Organization for Economic Cooperation and Development on May 22 cited the fiscal crisis among the risks to the global economy, when lowering its euro-zone forecasts for this year and next. The 17-nation economy will shrink 0.1 percent in 2012 before expanding 0.9 percent in 2013. The OECD had previously forecast growth of 0.2 percent and 1.4 percent, respectively.

“Such persistent weakness reflects underlying economic fiscal and financial imbalances within the euro area, which have been the root cause of this crisis and barely begun to unwind,” OECD Chief Economist Pier Carlo Padoan said in a statement. “Recovery in healthier countries, while welcome, is not strong enough to offset flat or negative growth elsewhere.”

Below-50 Readings

Economic data from China added to concerns that growth in Asia is in danger as the world grapples with the continuing debt crisis in Europe. Chinese manufacturing may shrink for a seventh month in May, a purchasing managers’ index released by HSBC Holdings Plc (HSBA) and Markit indicated. If confirmed on June 1, it would mark the longest run of below-50 readings since the global financial crisis.

With European households cutting spending and global economies cooling, companies may struggle to maintain their sales growth. Metro AG (MEO), Germany’s biggest retailer, said on May 23 that profit won’t rise this year, with Chief Executive Officer Olaf Koch saying while 2011 “was not an easy year,” the current year “will not be any easier.”

‘Island of Happiness’

Germany’s faltering economy means the euro-zone economy may lose a support that has helped soften the impact of recessions from Spain to Italy. German domestic demand dropped 0.3 percent in the first quarter from the previous three months, while construction slumped 1.3 percent and gross fixed capital spending decreased 1.1 percent, a report showed today.

“Until recently, it seemed as if the German economy had turned into an island of happiness,” said Carsten Brzeski, an economist at ING Group in Brussels. Today’s business confidence indicator “however, is a clear signal that even the new German magnificence could come to an end.”

The European Commission is scheduled to release an indicator of euro-area economic confidence on May 30.

To contact the reporter on this story: Simone Meier in Zurich at smeier@bloomberg.net

To contact the editor responsible for this story: Matthew Brockett at mbrockett1@bloomberg.net

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