Euro zone economic activity contracts at fastest pace in over two years in May, PMI shows

LONDON, May 21 (Reuters) - Economic activity in the euro zone shrank at its sharpest rate in more than two-and-a-half years in May, as a war-driven surge in living costs hammered demand for services and pushed overall input price inflation to its highest in three-and-a-half years, a survey showed on Thursday.

S&P Global's Flash Euro Zone Composite Purchasing Managers' Index fell to 47.5 in May from 48.8 - its lowest since October 2023 - and below a Reuters poll forecast which predicted no change from April. The reading marked the second consecutive month of contraction across the bloc's private sector.

A PMI below 50.0 indicates slowing activity.

"May's flash PMI survey data show the euro zone economy taking an increasingly severe toll from the war in the Middle East," said Chris Williamson, chief business economist at S&P Global Market Intelligence. "The survey data indicate the euro area economy looks set to contract 0.2% in the second quarter."

Overall demand deteriorated sharply. New orders across the private sector fell at their fastest pace in 18 months, with new export orders - including intra-euro zone trade - declining at the steepest rate since January 2025. Services new business dropped sharply, while factory demand, which had posted a rise in April, swung back into decline.

"The service sector is being hit especially hard by the surge in the cost of living created by the war, notably via the demand-sapping impact of higher energy prices," Williamson added.

Services activity - the dominant driver of the euro zone economy and a key gauge of consumer demand - contracted at the sharpest pace since February 2021, with the Flash Services PMI falling to 46.4 from 47.6 in April, against a poll finding for a modest uptick to 47.7.

Cost pressures intensified sharply. Input price inflation accelerated to a three-and-a-half year high, the composite PMI showed. Prices charged to customers also rose at their fastest pace in 38 months, though only marginally faster than in April. S&P Global warned the price gauges point to inflation running close to 4% in coming months. The European Central Bank left interest rates unchanged late last month but extensively debated a hike to combat soaring inflation and signalled both on and off the record it may pull the trigger in June.

Inflation in the common currency area held at 3.0% in April, official data showed on Wednesday, above the ECB's 2.0% target.

The labour market deteriorated further. Euro zone companies cut headcount for a fifth consecutive month, with the pace of job losses the steepest since November 2020 - and, excluding the pandemic, the largest since August 2013. Services firms reduced headcount for the first time since early 2021, while manufacturing payrolls shrank again.

Business confidence dropped to a 32-month low, with services firms the most pessimistic since September 2022. (Reporting by Jonathan Cable; Editing by Toby Chopra)