Economic sentiment in the euro zone worsened more than expected this month with optimism fading in all sectors, data showed on Thursday, signalling slower expansion of the region's economy in the second half of this year, according to Reuters. The European Commission's monthly sentiment index, based on a survey of businessmen and consumers across the 17-nation euro zone, fell to 103.2 in July from 105.4 in June. This month's figure was the lowest reading since 102.2 in August 2010. Analysts polled by Reuters had expected the index, which has been falling every month since February, to drop to 104.0 in July. The index is calculated from the balance of positive and negative replies to questions on confidence in the economy; its long-term average is 100. "It is a clear soft patch, worse than expected. Bad news, clearly. We are on a downward trend since the start of the year," said Carsten Brzeski, economist at ING. He and other analysts said sentiment had been hit by the sovereign debt crises in several weak euro zone states, as well as by signs of weaker growth in countries such as China and the United States. But they said the euro zone was probably not heading back into recession, after emerging from one in 2009. "Given that euro zone fundamentals remain sound, we stick to our view that this is not the beginning of a new downturn, but rather a mid-cycle slowdown," said Chiara Corsa, economist at Unicredit. The Commission said sentiment in industry worsened to 1.1 from 3.5, in services to 7.9 from 10.1, and among consumers to -11.2 from -9.7. "Today's data signal that the slowdown is set to continue in the second half of the year. The Composite Purchasing Managers Index for activity released last week showed a similar trend," said Clemente De Lucia, economist at BNP Paribas. The sentiment data, as well as market jitters about Italy's ability to cope with its sovereign debt, pushed the euro down to around $1.4280 on Thursday morning from $1.4370. A Reuters poll of analysts conducted in mid-July predicted the euro zone's economy would grow just 0.4 percent per quarter from now until next April -- much slower than the 0.8 percent recorded in the first quarter of this year. INTEREST RATES Combined with continued pressure for higher inflation in the euro zone, Thursday's data may sharpen the European Central Bank's dilemma over whether to raise interest rates further this year, after a 0.25 percentage point hike in its key rate this month. Although the survey found selling price expectations among manufacturers fell sharply in July to 12.5 from 16.1, consumer inflation expectations 12 months ahead inched up to 25.4 from 24.6. Preliminary data from Germany on Wednesday showed its consumer price inflation rose to 2.4 percent in July, suggesting this Friday's reading for the whole euro zone could exceed the 2.7 percent forecast by economists -- well above the ECB's target of close to but below 2 percent. Meanwhile, euro zone countries hit by debt crises are growing much more slowly than healthy ones, leaving them vulnerable to any further interest rate hikes. Capacity utilisation in the euro zone, a measure of how much of the economy's installed potential is being used, fell from the previous quarter in July for the first time in two years, Thursday's survey found. But this masked big divergences among countries, with Germany remaining above its long-term average and economies on the periphery of the region lagging. "The ECB currently seems minded to raise interest rates again before the end of 2011 after hiking by 25 basis points in both April and July," said Howard Archer, economist at IHS Global Insight. "However, while a further interest rate hike in the fourth quarter is clearly very possible, we suspect that markedly slower euro zone growth and likely recurrent sovereign debt tensions will present an increasingly compelling case for the ECB to hold off from further monetary policy tightening this year." The Commission's business climate index, which points to the phase in the business cycle, tumbled to 0.45 in July from 0.95, giving its lowest reading since June 2010 when it was 0.36.
