Eurozone services activity in October expanded at the fastest pace since 2007. However, the recovery is characterised by ongoing job losses and price discounting.

On Tuesday, the European Commission said in its autumn forecast that the Eurozone will return to gradual growth in 2010 and it raised its forecasts as budget deficits and unemployment rise to the highest levels since at least 1995 - - see Related below.

At 52.6, the final Markit Eurozone Services Business Activity Index for October rose above both the flash estimate for the month (52.3) and the September result (50.9) to signal the second successive monthly increase in activity and the strongest monthly gain since December 2007.

The index is based on a single question asking the panel of 2,000 service sector companies to report on their actual business activity levels (or output) at mid-month compared to the previous month. Activity levels fell continually between June of last year and August of this year, with the rate of contraction peaking in February.

The expansion of activity masked growing variations between euro nations, however. France led the expansion by a considerable margin, seeing the rate of growth surge to a 20-month high, followed by a far more modest rise in Italy, which saw its first increase in activity for 23 months. A third successive expansion was reported in Germany, but the rate of increase slowed for the second month running to register only a marginal increase. Spain meanwhile continued to lag behind in the recovery, recording a contraction of activity for the twenty-second straight month. However, the rate of decline was the weakest seen over this period.

New business rose at a faster pace than indicated by the flash, growing for the second month running and registering the largest rise for almost two years. France easily led the growth of new business among the big-four euro nations, with far more modest increases seen in Germany and Italy (the latter seeing the first rise for two years). New business fell sharply again in Spain, however, with only a very marginal easing in the rate of contraction compared to that seen in the previous two months.

Confidence

Expectations about business activity levels at respondents’ companies in 12 months’ time came in slightly higher than the flash estimate, but were below September’s 44-month high. Optimism about the year ahead slipped in all big-four euro nations. Nevertheless, optimists continued to heavily outweigh pessimists across the Eurozone, representing a marked contrast to the situation earlier in the year and raising hopes of a continuation to the recovery of the sector in coming months.

Capacity and employment

The Employment Index edged up higher than the flash reading but still pointed to a sixteenth consecutive monthly drop in payroll numbers. The rate of job losses eased compared with September but continued to run at a pace rarely seen in the 11-year history of the survey prior to the recent recession. A stabilisation of employment in Germany was offset by falling levels in the other big-four euro nations. Rates of job losses slowed in Spain and Italy, but picked up in France as companies focused on cost cutting.

Employment was cut in order to adjust capacity to workloads, and a further marked drop in backlogs of work suggested that staff levels continue to exceed the numbers needed to meet current flows of new business. However, with backlogs falling at the slowest pace since August of last year, the rate of job losses looks set to moderate in coming months if current inflows of work are sustained.

Prices

Input costs fell for the ninth month running, but the decline was only marginal and the smallest seen over this period (and less than indicated by the flash). Moreover, of the big-four only French service providers reported lower costs, with increases reported in Germany, Italy and Spain as higher energy and staffing costs in particular exerted upward pressure.

The survey shows that prices charged by service providers fell by less than estimated by the flash release, registering the weakest fall (by a small margin) since last December. However, the rate of decline remained intense, and stronger than seen at any time over the survey’s history prior to the recent downturn, as fierce competition within both consumer and business services markets prompted ongoing widespread discounting, especially in France and Spain. Charges fell in all big-four countries, with the rate of decline the least severe in Germany and the sharpest in France and Spain.

Commenting on the data, Markit chief economist, Chris Williamson said: “The return to growth of service sector activity is particularly encouraging as it points to an increasingly broad-based, and therefore hopefully more sustainable, upturn in the euro area. France in particular is seeing services activity increase sharply to help drive the region out of recession, making up for some loss of momentum in Germany. Italy has now also bounced back to growth, leaving Spain as the only big-four country to not yet see an end to the recession in services.

“However, with prices charged still falling sharply, especially in France, it is likely that much of the return to growth is being achieved only through fierce price discounting.”

The Eurozone Services PMI (Purchasing Managers' Index) is produced by Markit Economics and is based on original survey data collected from a representative panel of around 2000 private service sector firms.