Concerns About Growth in Euro Zone Rise

WSJ: Weaker Business Activity Suggests a Need for Additional Central-Bank Stimulus to Head Off a More-Severe Downturn

FRANKFURT—Euro-zone business activity weakened further in March, according to a closely watched survey, raising concerns that improved financial-market sentiment about Europe's sovereign-debt crisis isn't leading to economic growth.

The unexpected drop in the purchasing managers' index survey suggests more stimulus from the European Central Bank through interest-rate cuts or additional bank lending may be required to protect the economy from a more severe downturn.

At a minimum, some analysts said, the recessionary signals make it appear that ECB officials were overly optimistic in recent statements that the euro bloc is on track for recovery and the central bank can start discussing ways to unwind its crisis measures.

"The euro zone is far from out of the economic woods," said Howard Archer, economist at consultancy IHS Global Insight in London.

The euro-zone PMI slid 0.6 point to a three-month low of 48.7 in March, according to data-services firm Markit, which compiles the index based on a survey of purchasing executives at euro-zone businesses. Economists had expected a slight rise. Index readings below 50 signal contraction in activity.

German PMI, which includes both manufacturing and services, fell from February but, at 51.4, signaled continued growth in Europe's biggest economy. France's index slid 1.2 points, to 49, putting Europe's second-largest economy back into contraction.

Details for other euro-zone countries won't be released until early April, but Markit said output "dropped sharply again in the rest of the region."

In another grim sign, industrial orders plunged 2.3% in January from December, according to the European Union's statistics agency.

Mr. Archer said the reports suggest euro-zone gross domestic product will contract over 1% this quarter at an annualized rate, and a further 0.5% next quarter. The region's GDP shrank 1.3% from October to December, at an annualized rate. Economists in Europe generally define recession as back-to-back drops in quarterly GDP.

The latest reports highlight the divergence between the euro zone and other economic regions. The U.S. has posted solid, if unspectacular, growth in recent quarters and unemployment has declined steadily. Emerging economies such as China are slowing, but they are still expected to see generally robust growth rates this year.

Any European recession is unlikely to be as severe as the one that gripped much of the global economy in 2008 and 2009.

Even if the downturn is mild, economists warn the euro zone lacks a clear path to stronger growth even in 2013. Unemployment is at a 15-year high of 10.7% and likely to rise further. Fiscal austerity across much of Europe will drain household disposable incomes and reduce public-sector jobs, further depressing spending. Recoveries outside Europe will provide some lift to export-sensitive Germany, but little help to the rest of the euro bloc.

Against that backdrop, Mr. Archer expects the ECB to eventually lower its main policy rate by 0.25 percentage point, to 0.75%, though he said a move at next month's meeting is unlikely. ECB President Mario Draghi cited a weakened PMI index in November when the ECB lowered interest rates.

Officials have in recent weeks struck a more optimistic tone on the economy, lowering the likelihood of imminent rate cuts. At its monthly meeting two weeks ago, the central bank warned that inflation risks were skewed to the upside and that some "stabilization" was evident in the economy.

Meanwhile, some policy makers have started paving the way for a return to the ECB's precrisis policies.

Just days after the ECB lent banks more than €500 billion ($662 billion) in three-year loans on Feb. 29—bringing the total of two installments to more than €1 trillion—the head of Germany's central bank said the ECB needed to begin discussing ways to exit its crisis measures. The heads of the Finnish and Austrian central banks have also stressed the need for an exit strategy.

Reflecting the bank's renewed anti-inflation tone, Mr. Draghi told the German daily Bild in an interview published Thursday that the ECB "will act immediately and preventively" if the inflation outlook worsens.

Analysts say such public pronouncements blunt the effectiveness of the ECB's crisis policies and may destabilize markets and the economy. If investors doubt the ECB's resolve, market tensions could flare up again. "They've got to be careful about undermining sentiment, which is already very fragile," Mr. Archer said.

Carsten Brzeski, economist at ING Bank in Brussels, sees risks of a replay of 2010 and early 2011, when ECB officials publicly touted plans to shift away from emergency lending policies even as the debt crisis intensified. Officials raised rates twice last spring and summer, only to reverse themselves with back-to-back cuts late last year.

"Haven't they learned the lesson of jumping the gun?" Mr. Brzeski asked. Pivoting from crisis fighting to a more restrictive stance now "wouldn't make sense and would be counterproductive," he said.

Write to Brian Blackstone