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Euro zone economy stutters as ECB gears up for action

By Jonathan Cable

LONDON (Reuters) - Price cuts by euro zone firms failed to prevent business growth from losing momentum in May, all but sealing the case for looser monetary policy a day before the European Central Bank meets.

Markit's Composite Purchasing Managers' Index (PMI) showed that while output across the bloc remained solid in May the pace of growth eased - despite output prices falling for the 26th straight month.

"Today's PMIs remain consistent with some recovery in the euro zone," said Annalisa Piazza at Newedge Strategy.

"That said, we rule out that the picture of moderate recovery will be an obstacle for the ECB to justify further accommodation this week."

ECB policymakers have flagged a move at Thursday's meeting. Sources told Reuters last month the bank was preparing a package of policy options, including cuts in all its interest rates and targeted measures aimed at boosting lending to small and mid-sized businesses.

Annual euro zone inflation, which the ECB prefers to be just under 2 percent, fell unexpectedly in May to just 0.5 percent, increasing the risks of deflation and making a policy response on Thursday a virtual certainty.

Industrial producer prices, a proxy for consumer prices, fell as expected both on the month and on a year ago in April, Eurostat also said on Wednesday.

In Britain, which does not use the euro, the services industry expanded faster than expected in May, and hiring notched a 17-year high, adding to a debate at the Bank of England about how soon it should raise rates.

The BoE is widely expected to be the first major central bank to begin hiking interest rates from a record low of 0.5 percent - although not until next year.

"Record low interest rates are no longer necessary. The (UK) economy is growing rapidly and, if anything, is picking up pace," said Christian Schulz at Berenberg.

DIFFERENT ROADS

Just as Britain's recovery seems to be progressing at a faster rate than that of the neighboring euro zone economy, parallel divergences have emerged within the currency union.

The bloc's growth was once again supported by Germany and pointed to euro zone GDP expanding 0.4-0.5 percent this quarter. But French business activity slipped back into contraction after just two months of growth.

Similarly, accelerating growth in the service industry was offset by an easing in manufacturing.

The Composite PMI, widely seen as a good gauge of growth, dipped to 53.5 in May, shy of a flash reading of 53.9 and below April's final 54.0. But it held above the 50 mark dividing growth from contraction for the 11th month running.

The slowdown in growth came despite firms again cutting prices. The output price index nudged up to 48.8 from 48.7 but has held below the break-even mark since April 2012.

"The overall rate of growth is just not strong enough to allow firms to push through price hikes. This is perhaps the final nail in the coffin for hopes of a robust recovery without stimulus," said Chris Williamson, chief economist at Markit.

The index for the euro zone's vast service industry rose to a near three-year high of 53.2 in May from 53.1 in April as new business came in at its fastest pace since mid-2011, with the related subindex rising to 52.8 from 52.3.

First quarter GDP growth was confirmed at just 0.2 percent earlier on Wednesday, leaving currency and bond markets little moved as they await the ECB's decision on Thursday.

(Editing by John Stonestreet)

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