Europe's economy hit hard as energy price shock stifles demand

LONDON - 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 across Europe and firms accelerated layoffs, surveys showed on Thursday.

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

A PMI below 50.0 indicates slowing activity.

The data "provides more evidence that the euro zone economy is at risk of contracting in Q2 while the increase in the input and output price components underlines the case for tighter monetary policy," said Andrew Kenningham at Capital Economics.

Consumer confidence weakened further in the euro area this month, figures are expected to show later on Thursday.

Private sector activity in Germany, Europe's largest economy, contracted for a second consecutive month in May while in France the headline PMI fell to its lowest in five-and-a-half years with firms frequently citing fuel and energy cost pressures, as well as general economic angst, as reasons for lower output.

In Britain, outside the European Union, companies suffered their most widespread drop in activity in over a year due to the economic fallout from the Iran war and political uncertainty at home.

DEMAND FOR SERVICES HIT HARD BY RISING COSTS

Overall demand in the euro zone 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.

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.

The manufacturing PMI fell to 51.4 from 52.2, below expectations. The output PMI, which feeds into the composite reading, also dropped to 51.0 from 52.3.

And those numbers were likely falsely elevated by supply issues lengthening delivery times of factory goods to their worst since the COVID-19 pandemic due to the U.S.-Israeli war with Iran and the closure of the key shipping route of the Strait of Hormuz.

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.

Policymaker Olli Rehn said in an interview the ECB may raise interest rates to preserve credibility in the face of a war-driven rise in fuel costs but there is little to suggest yet high inflation is taking root in the euro area.

"There is nothing here to put the ECB Governing Council off its plans to raise rates by 25 basis points in June, nor anything to ease concerns about the risks of a recession," Kenningham added.

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)

Copyright Reuters or USA Today Network via Reuters Connect.

This story was originally published May 21, 2026 at 2:43 AM.