Japan May Core CPI Annual Rate Rises to 2.5% from 2.2% in April as Higher Renewable Energy Charge Boosts Utility Bills

Economic

Central Bank

Summary:

Japan inflation rose in May. Energy and processed food prices up. Central bank likely to raise rates soon.

Consumer inflation in Japan accelerated in two of three key measures in May as the government raised the renewable energy charge that users pay for greener electricity but the largest contribution to the year-over-year increase in the CPI remains processed food prices, data from the Ministry of Internal Affairs and Communication released Friday showed.

The core CPI (excluding fresh food prices), closely watched by the Bank of Japan for its policy stance, rose 2.5% on year in May after rising at a three-month low of 2.2% in April and 2.6 percent in March, coming in slightly below the consensus call of a 2.6% increase. The year-over-year increase in the total CPI rose to a three-month high of 2.8% after easing to 2.5% in April from 2.7% in March. It was also below the median forecast of a 2.9% rise.

Underlying inflation measured by the core-core CPI (excluding fresh food and energy) decelerated to a 20-month low of 2.1% from 2.4%, also just under the median forecast of a 2.2% rise. The annual rate for this narrow indicator had been at or above 3.0 percent from December 2022 until February 2024.

Overall energy prices jumped 7.2% on year in May, pushing up the CPI by 0.54 percentage point, after edging up 0.1% with a slightly positive 0.01-point contribution in April. Food prices excluding perishables continued to ease to a 3.2% increase from 3.5% but this category remains the largest contributor, raising the CPI by 0.76 point, although it is smaller than plus 0.83 point seen the previous month.

Services costs have led overall inflation until recently as firms are raising wages to secure workers amid widespread labor shortages. Service prices excluding owners’ equivalent rent rose 2.2% on the year in May, pushing up the total CPI by 0.71 percentage point, following a 2.5% rise (plus 0.79 point) in April. Goods prices excluding fresh food gained 3.5% (plus 1.69 points), rising sharply from a 2.6% rise (plus 1.28 point) as utility costs showed a hefty increase in May after falling for more than a year.

In coming months, the BOJ board is expected to raise the overnight interest rate target gradually. At its latest meeting on June 13-14, the nine-member board decided in a unanimous vote to hold the overnight interest rate target steady in a range of 0% to 0.1% for the second straight meeting after conducting its first rate hike in 17 years and ending the seven-year-old yield curve control framework in March.

Other details from CPI data:

* The national average core consumer price index (excluding fresh food) rose 2.5% from a year earlier in May for the 33rd year-on-year increase, up from 2.2% in April. It is well below the 4.2% surge in January 2023, which was a 41-year high and the largest increase since the 4.2% gain in September 1981.

* The underlying inflation rate — measured by the core-core CPI (excluding fresh food and energy) — rose 2.1% on the year in May for the 26th straight year-over-year increase, slowing further from 2.4% in April. The pace of increase remains the slowest since the 1.8% gain in September 2022. The 4.3% annual rate recorded in May, July and August 2023 was the largest in 42 years, since the 4.5% increase June 1981.

* The total CPI rose 2.8% on year in May for the 33rd consecutive year-over-year increase, up from 2.5% in April and matched the 2.8% rise in February. The 4.3% increase in January 2023 was a 41-year high, the largest since the 4.3% rise in December 1981. Fresh food prices, a volatile factor, rose 8.8% on year and pushed up the overall index by 0.38 percentage point in April after rising 9.1% (up 0.38 point) the previous month.

* Among key components of the CPI basket of goods and services, energy prices jumped 7.2% on year in May, pushing up the CPI by as much as 0.54 percentage point, after edging up 0.1% with a positive 0.01-piont contribution in April. This compares with a 12.1% drop (minus 1.07 points) at the start of the year. The 0.7% drop (minus 0.06 point) in February 2023 was the first decline since March 2021.

* Gasoline prices rose 4.5% on the year, adding 0.09 percentage point to the CPI, little changed from a 4.4% gain (a positive 0.09-point contribution) the previous month.

* Electricity charges soared 14.7% on year (a positive 0.47-point contribution) after sliding 1.1% (minus 0.04 point) in April and plunging 21.0% (minus 0.90 point) in January. In February 2023, they marked the first drop since July 2021. The government began providing utilities subsidies in January 2023 (reflected in February bills onward). The program was extended until the end of May 2024.

* The prices for natural gas supplied to homes fell 3.2% with a negative 0.03-point contribution, with the year-on-year decline shrinking further from a 5.9% drop (minus 0.07 point) in April from a 22.8% plunge (minus 0.30 point) in January.

* The prices for food excluding perishables, which has a large weight in the CPI basket, posted the 35th straight year-on-year increase but the pace slowed further to 3.2% (plus 0.76 point) in May from 3.5% (plus 0.83 point) in April. The pace of increase has eased from a recent peak of 9.2% (plus 2.08 points) in August and July 2023, which was the largest increase in more than 46 years since the 9.9% surge in October 1975.

* The prices for household durable goods marked their 26th consecutive gain, with the pace of increase picking up to 1.9% (plus 0.03 point) in May after decelerating to 0.5% (plus 0.01 point) in April from 1.9% (plus 0.03 point) in March.

* Accommodations, which have a relatively small weight in the CPI basket of goods and services, rose 14.7% on year (plus 0.15 point) in April, slowing from 18.8% (plus 0.19 point) in April. The 59.0% jump (plus 0.43 point) in December 2023 was in reaction to a slump in hotel fees in late 2022. The government in October that year began subsidizing domestic travel under a new nationwide program to support the pandemic-hit tourism industry. It was phased out by the end of 2023.

Source: MaceNews

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Samantha Luan

Economic

Stocks

MSCI's broad index of global stocks was flat on the day, although still on track for a 0.8 per cent weekly rise, taking its monthly gain to more than 2 per cent.

Europe's Stoxx share index also opened flat, while futures trading implied Wall Street's S&P 500 would also drift sideways in early New York dealings.

The mood was indecisive ahead of the release later in the day of S&P Global's U.S. purchasing manager indices, viewed as real-time snapshots of business confidence and economic activity.

Economists polled by Reuters expect this month's indices to produce readings above the level of 50 that show activity is expanding, but to have fallen slightly since last month.

A robust U.S. economy has propelled Wall Street stocks to record levels and dissuaded the Federal Reserve from cutting interest rates from their 23-year high of 5.25 per cent to 5.5 per cent.

Markets are currently clinging to a narrative that the economy and inflation will decelerate by just enough for the Fed to ease financial conditions gradually.

But that ignores risks such as the lagged effects of tight monetary policy causing a hard slowdown, or further economic growth keeping rates high for longer, Russell Investments global head of investment strategy Andrew Pease said.

"I'd be concerned about higher (market) volatility in coming months as the market oscillates between seeing the soft landing and worrying that maybe it's not going to happen," he said.

Meanwhile relentless strength in the U.S. dollar on Friday pushed the Japanese yen towards the intervention zone.

The yen dropped to 158.77 per dollar, close to its levels in late April when Japanese authorities intervened to try and stem the currency's rapid decline.

Data showed earlier on Friday that Japan's demand-led inflation slowed in May.

That complicated the outlook for how quickly the Bank of Japan might move towards interest rate hikes after it ended negative rates in March in a landmark signal the nation might have ended a long era of deflation and demographic decline.

BoJ deputy governor Shinichi Uchida said on Friday that the central bank was willing to raise rates if the economy and prices move in line with its forecasts, but signs of weakness remained.

The dollar was also benefiting from a growing divergence between Fed policy and that of central banks in Europe. On Thursday the Swiss National Bank cut rates for a second time, while the Bank of England opened the door to easing in August or September after holding rates steady.

Sterling, the Swiss franc and the euro also weakened against the dollar on Friday.

MSCI's broadest index of Asia-Pacific shares outside Japan fell 0.6 per cent on Friday, dragged lower by a pull-back in technology shares in a repeat of patterns on Wall Street in the previous session.

In debt markets, U.S. Treasuries were set to end the week on the back foot as Fed rate cut doubts lowered the appeal of the fixed interest-paying securities.

Two-year Treasury yields were headed for a weekly rise of 3 basis points to 4.7151 per cent, while the 10-year yield is 2 bps higher this week, trading at 4.2341 per cent. Bond yields rise as prices fall.

Germany's ten-year bund yield was also 3 bps higher on the week at 2.382 per cent.

UK government bonds have outperformed, with the 10-year gilt yield 4 bps lower at 4.016 per cent, reflecting hopes of BoE rate cuts and as predictions of the opposition Labour Party winning next month's UK election drew investors back to British markets.

Brent crude futures edged 0.3 per cent lower to $85.51 a barrel after hitting seven-week highs earlier in the week.

Source:Reuters

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Warren Takunda

Economic

Stocks

London stocks were set for a flat open on Friday as investors mulled the latest retail sales data and consumer confidence reading.

The FTSE 100 was called to open unchanged at 8272.

It’s worth noting that Friday is ‘triple witching day’. Ipek Ozkardeskaya, senior analyst at Swissquote Bank, said: "About $5.5 trillion index futures, options, stock options and ETFs will expire at the same time.

"Given that we are at psychologically crucial, irrationally high, and mathematically overstretched levels, we could see surprise turns and twists in positioning."

On the macro front, figures released earlier by the Office for National Statistics showed that retail sales rose 2.9% in May, versus expectations for a 1.5% jump. This followed a 1.8% decline in April, which was revised from a 2.3% fall previously reported.

The ONS said sales volumes rose across most sectors, with clothing retailers and furniture stores rebounding following poor weather in April.

The data showed that non-food store sales volumes - the total of department, clothing, household, and other non-food stores - rose 3.5% in May. This was the largest monthly rise since April 2021, and followed a 3% fall in April.

On the year, retail sales were up 1.3% in May and were 0.5% below their pre- pandemic level in February 2020.

Elsewhere, a survey showed UK consumer confidence strengthened in June as hopes for the economic recovery gained ground.

The latest UK consumer confidence index from GfK was -14, up three points on May and well above June 2023, when it was -24.

Within that, confidence in the economic situation over the next year jumped six points to -11.

Respondents also adopted a more positive overview of the economy over the last 12 months, with the measure ahead seven points at -32.

The forward-looking personal financial situation measure dipped three points, however, to 4. The major purchase index, meanwhile, rose three points to -23.

Joe Staton, client strategy director at GfK, said: "While June’s reading of -14 is the third month in a row that confidence has increased, the headline score remains negative owing to the difficulty so many have experienced, as the unrelenting cost of living crisis batters household budgets.

"Nevertheless, consumer confidence continues its robust long-term upwards trend this month, and has recovered significantly since the record low of -49, in September 2022.

"Consumers like financial certainty, and this has to be the cornerstone if we are to see confidence to break out into positive territory."

Still to come, UK services and manufacturing PMIs for June are due at 0930 BST.

In corporate news, events group Informa said it was on track to deliver earnings at the upper end of guidance as revenues grew by 10.1% in the year to date.

Sales hit £1.4bn in the period, with a further £1bn of subscriptions/exhibitor revenue committed and visible in 2024, and strong events rebooking into 2025, the company said in a statement ahead of its annual general shareholder meeting.

Compass Group announced that it had agreed to repurchase up to $250m of its shares between 21 June and 17 December, as part of the final stage of its $500m share buyback plan.

The company said the purpose of the plan was to reduce its share capital by returning surplus capital to shareholders.

Source: Sharecast

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Economic

Central Bank

Will PCE data confirm Fed rate cut bets?

Although the Fed's updated dot plot pointed to only one quarter-point reduction by the end of the year, the softer-than-expected CPI numbers a few hours ahead of last week's decision did not convince market participants about officials' intentions. The weaker-than-expected retail sales numbers this week corroborated that view.

Indeed, according to Fed funds futures, investors are penciling in around 50bps worth of reductions by the end of the year, assigning around a 70% probability for the first cut to be delivered in September. Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_1

Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_1

With all that in mind, the main item on dollar traders' agenda next week may be the core PCE price index for May due out on Friday, which is accompanied by the personal income and spending data for the same month. The final GDP print for Q1 is also set to be released the day before, but given that Q2 is almost over, any minor deviations from the 2nd estimate are likely to pass unnoticed.

As for the core PCE index, the slide in the core CPI for the month poses some downside risks. There may be downside risks to spending as well, derived by the weakness in retail sales, although income may be poised to improve, something suggested by the better-than-expected average hourly earnings. Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_2

Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_2

Overall, another set of economic data pointing to cooling consumer demand may further solidify expectations of two quarter-point cuts by the Fed, and perhaps increase the probability for initiating the process in September. This could prove negative for the US dollar, especially against its Australian counterpart. Remember that this week, the RBA maintained its neutral stance, while Governor Bullock revealed that they discussed the option of raising rates.

How likely is a July hike by the BoJ?

In Japan, the Summary of Opinions from last week's BoJ decision will be released on Monday during the Asian session, while on Friday, the Tokyo CPIs for June are coming out.

At last week's meeting, BoJ officials decided to keep interest rates unchanged and said that they would start trimming their bond purchases, but that they will announce a detailed plan next month. What's more, Governor Ueda said that he is not ruling out interest rates in July.

Still, the yen fell, perhaps as some market participants were expecting more concrete signals about a July hike and a potential slowdown in bond purchases. This is also evident by market pricing, where the probability of a 10bps hike in July has dropped significantly, to around 27%. Ahead of the decision that chance was more than 65%.

All this suggests that yen traders will dig into the summary for clearer hints on how likely a July hike is. If they are left once again disappointed, the yen is likely to extend its slide and perhaps take another hit if the Tokyo CPIs pull back below the Bank's 2% objective again. Having said all that though, with dollar/yen already trading near the 159.00 zone, further advances, closer to the round number of 160.00, may significantly increase the risk for another intervention episode by Japanese authorities, although officials have been silent until now. Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_3

Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_3

Back-to-back rate cuts for the BoC?

Canada's CPI numbers are also on next week's agenda. They are due out on Tuesday. Earlier this month, the BoC became the second central bank in the G10 group to cut interest rates by 25bps, with Governor Macklem signaling that it would be "reasonable to expect further cuts" if inflation continues to cool.

Since then, the only data set worth mentioning was the employment report for May, which came in slightly better than expected. And that was not enough to deter investors from expecting another rate reduction in July. The probability of such a move currently rests at around 62% and should next week's data reveal that inflation continued its downward trajectory, it could go higher. This could weigh on the Canadian dollar. Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_4

Week Ahead – US PCE Inflation the Highlight of a Relatively Light Agenda_4

Australia releases its monthly CPI prints for May. Inflation in Australia has been proving stickier than other major economies, with RBA policymakers discussing the possibility of hiking rates at Tuesday's gathering. Ergo, if the CPI confirms the stickiness in price pressures, traders will continue seeing the RBA as more hawkish than other major central banks, something that may keep the aussie supported.

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Devin

Economic

Bond

Any sustained bet against French government debt can only hinge on a belief in the improbable end of the euro - even if the European Central Bank needs to walk a fine line in how and when it responds.

The playbook from the existential euro crisis of 2010-2012 suggests that even if investors feel emboldened enough to speculate about smaller peripheral euro countries being forced to exit the bloc, a euro zone without France most likely means no euro zone at all.

In other words, there is no such thing as "Frexit" in isolation - if by Frexit people mean France could leave the currency union while a functioning euro zone still exists. France's central position to the entire construct, for most investors, renders it a binary all-or-nothing outcome.

And that's a big punt given the firepower loaded against it.

Framed by 2012's pivotal "whatever it takes" moment from then ECB chief Mario Draghi, the ECB has shown repeatedly ever since it will do all in its remit to sustain its only "raison d'etre" as guardian of the single currency and its functioning.

Even though the root of the latest French political upheaval and snap election is the rise of far-right and left parties much less favourable to the whole European Union project, membership of the euro per se is likely not up for debate - not even by the far-right that once questioned it.

While surveys on French attitudes towards the EU do show up a mixed bag of dissatisfaction towards various aspects of the Union's workings, more than 70% remained in favour of the single currency through last year. There's Likely No Such Thing as 'Frexit'_1

There's Likely No Such Thing as 'Frexit'_1

'Hand in hand'

That doesn't escape the concern about the French deficit and debt - crystallized by the EU itself this week in kicking off protracted disciplinary procedures against France and others and also by S&P Global in downgrading France's sovereign credit rating to AA- last month.

And the spending plans of parties leading opinion polls ahead of the June 30-July 9 assembly election appear ready to throw fuel on the flames rather than chime in with EU rules on lowering the annual deficit to 3% of GDP from the whopping 5.5% last year.

But France won't be alone in that among G7 peers. The issue is whether there's a peculiar twist within the euro zone to the wider global angst about mounting public debts.

And that rests on what level of risk premium the ECB is likely to tolerate between major member states.

For the ECB, the widening French debt spreads relative to Germany has its limits if it were to threaten French debt sustainability, fragment euro credit provision or hamper the smooth working of its monetary policy evenly across the bloc.

The latest in a long line of ECB initiatives aimed at curbing what it deems unwarranted speculation against individual euro country's debt is 2022's so-called Transmission Protection Instrument (TPI).

ECB chief economist Philip Lane this week made clear he saw no grounds yet for considering TPI as French market repricing to date had been modest and based on reasonable fundamentals. ECB President Christine Lagarde was more cryptic, saying: "Price stability goes hand in hand with financial stability."

ECB sources told Reuters it was first for the French government to reassure investors that all fiscal plans were in order and that would need the election to play out first.

What's more, activating the TPI is conditional on action on addressing the EU deficit rules and likely stays the ECB's hands for now in using it.

So there's a delicate balance to be drawn on how far this can go - even if there are clear limits.

"The ECB's intervention mechanisms mean that the eurozone does not face the same existential threats as its sovereign debt crisis of a dozen years ago," asset manager Lombard Odier said this week, adding the "moment of truth" might have to come if further spread widening forces any incoming government to comply with EU deficit demands in order to get the ECB to act. There's Likely No Such Thing as 'Frexit'_3

There's Likely No Such Thing as 'Frexit'_3

Loop The Loop

For all the disturbance - and perhaps reflecting investors awareness of the limits - we're not at critical points yet.

Even though the French-German debt spread widened to as much as 77 basis points after the snap election was called - the widest risk premium since 2017 - it's still half the peaks of the 2011-2012 shock.

And more significantly for any worries about debt sustainability, nominal French 10-year bond yields have done very little - rising about 15 basis points over the past month to 3.15%, still well below peaks of 3.6% seen only last October.

That, so far, likely distinguishes the episode from the 2022 British bond blowout under then Prime Minister Liz Truss that many have evoked as a possible comparison.

Demand for French debt at Thursday's latest auction, while affected by the turbulence, showed no sign yet of cratering.

Potentially more worrying has been the 10-15% drop in French banking stocks - as national bank stocks have often been the favoured route of euro debt speculation, in part due to the long-feared "doom loop" that could bind the two in a spiral.

That doom loop riffs off the idea that domestic banks hold disproportionately large sovereign debt holdings for regulatory capital and collateral purposes that could hamper their balance sheets in the event of big marked-to-market losses. It was at the heart of the 2010-2012 euro ructions.

Fears of a spiral then build if that bank exposure hits their equity and debt financing, liquidity or even solvency, putting the state on the hook for bailout of systemically important banks - further damaging the sovereign debt profile.

While a blow - not least to many global investors who had moved overweight euro zone banks lately - the near 20% drop in the French bank stocks over the past month so far just reverses the move higher from March to mid-May.

And the latest European Banking Authority stress tests showed the largest French banks still well insulated even in extreme adverse scenarios assuming a 5.7% drop in French GDP, 9.7% inflation and interest rates at 5.9%.

Thorny French politics and debt problems pack a punch - but a euro crisis redux is likely not part of it at the moment. There's Likely No Such Thing as 'Frexit'_5

There's Likely No Such Thing as 'Frexit'_5

Source: Reuters

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Warren Takunda

Economic

European shares may open in mixed territory on Friday. In Asia, stock benchmarks were mostly lower; Treasury yields ticked up; the dollar consolidated; while oil was mixed and gold gained.

Equities:

European stock futures were tracking mixed early Friday ahead of flash PMIs for the region.

U.S. stocks closed broadly lower on Thursday. Shares of Nvidia gave up early gains on Thursday, pulling the S&P 500 and Nasdaq Composite down from all-time highs.

Investors have been highly attuned to economic data for signs that inflation is easing, which could keep the Fed on track this year to cut interest rates, usually a boon to the stock market.

On tap today are provisional purchasing managers' surveys for June covering the manufacturing and services sectors' activity in Germany, France and the eurozone which will be watched closely for indications of how the economy is faring.

"According to our forecast, the purchasing managers' indices for June in the eurozone are set to show an overall consolidation of the recent improvement in sentiment," analysts at LBBW said.

Forex:

The U.S. dollar consolidated in Asia. The USD could retain some strength versus the euro as the Fed turns to more gradual interest-rate cutting than previously thought, Bank of America economists said and see the EUR/USD ending the year at 1.12.

Considering persistent U.S. inflation and "shallow easing cycle," BofA sees EUR/USD at 1.17 by the end of 2025 versus its previous 1.20 forecast, a long-term equilibrium it now sees been reached only in 2026.

BofA remains "more bearish on the USD than the consensus."

The Bank of England could cut interest rates in August but this might not be enough to reverse sterling's outperformance so far this year, MUFG Bank said noting that the sterling remains the second best performing G-10 currency after the dollar.

"Gradual BOE rates cuts are unlikely on their own to significantly undermine the pound's attractiveness in the second half of this year." In the near-term, European political risks should be a more important driver of sterling's performance, it added.

Bonds:

Treasury yields maintained their upward trajectory after rising Thursday.

"The data of the past few weeks have been signaling incremental labor market weakness, albeit from a position of extreme strength. It is still too early to tell if this is another step in the process of the labor market coming into better balance, or if it is the early stages of building momentum to the downside," Jefferies' economists said.

"We are inclined to think that it is the former, but we are cautiously watching the next few weeks worth of data to see if a trend is emerging."

Market participants are pricing in a roughly 64% probability the Fed will have cut rates by at least 25 basis points by its September meeting, according to the CME FedWatch tool.

Energy:

Oil futures were mixed after settling at fresh seven-week highs on Thursday on the back of weekly declines in U.S. crude and gasoline inventories, as rising geopolitical tensions lifted concerns about disruptions to global supply chains.

"These rising geopolitical tensions in Europe and the Middle East continue to support crude prices due to risks of disruptions to global supply chains. However, the increase in oil prices remains tempered by cautious remarks from U.S. Federal Reserve officials regarding interest rates and inflation trends," said Eman Al-Ayyaf, chief executive of EA Trading.

Metals:

Gold advanced early Friday. The precious metal had traded in a narrow range given uncertainty over the Fed's timeline for rate cuts, but Thursday's U.S. jobless claims staying near a 10-month high supports the case for a cut, said Joseph Dahrieh, managing principal at broker Tickmill.

The long-term outlook for gold is also bullish, with continuous central bank demand, potential renewed purchases from China's central bank and upcoming political elections in major economies expected to support its appeal as a safe-haven asset, Dahrieh added.

Iron ore fell in Asia. A wave of iron ore supply is coming, given rising iron ore inventories in China, and prices are likely to remain range-bound this year, Macquarie strategists said. Chinese domestic iron ore production is up this year, they noted.

Iron-ore production cuts among Chinese mills were unlikely to materialize in the short-term amid China's strong exports of steel, which uses iron ore as a raw material, they added.

Source: Morningstar

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Samantha Luan

Economic

Euro zone business growth slowed sharply this month as demand fell for the first time since February, a survey found, with the bloc's services industry showing some signs of weakening while the downturn in manufacturing took a turn for the worse.

That was despite the European Central Bank delivering a widely telegraphed cut to interest rates earlier this month and expectations in a Reuters poll for two more reductions this year.

HCOB's preliminary composite Purchasing Managers' Index, compiled by S&P Global, sank to 50.8 this month from May's 52.2, confounding expectations in a Reuters poll for a rise to 52.5.

However, June marked a fourth month above the 50 level separating growth from contraction.

"Is the recovery in the manufacturing sector ending before it began? The services sector continues to keep the euro zone afloat," said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank.

The overall new business index dropped to a four-month low of 49.2 from 51.6.

A PMI for the currency union's dominant services industry fell to 52.6 from 53.2. The Reuters poll predicted an uptick to 53.5.

But inflationary pressures eased, strengthening the case for further ECB interest rate cuts this year. The services output prices index declined to 53.7 from 54.2, its lowest reading in just over three years.

"The ECB, which cut interest rates in June, may feel vindicated by prices data which signalled easing pressure in the euro zone's service sector. However, the HCOB PMI do not provide ammunition for another rate cut in July by the ECB," de la Rubia added.

Manufacturing activity, in decline for almost two years, reversed recent signs of heading for a recovery. The factory PMI dropped to a six-month low of 45.6 from 47.3. Expectations in the Reuters poll were for a lift to 47.9.

An index measuring output plummeted to 46.0 from 49.3.

That downturn pushed factories to reduce headcount for a thirteenth month. The employment index fell to 47.5 from 47.9.