July 24, Thu Jul 24, 2014 4:06am

The euro zone's private sector expanded at the fastest rate in three months in July, although faster growth in new business was driven mainly by companies cutting prices again, surveys showed on Thursday.

Markit's Composite Purchasing Managers' Index (PMI), based on surveys of thousands of companies across the region and a good early indicator of overall growth, rose to 54.0 in July from 52.8, its highest since April. Any number above 50 indicates expansion.

The services sector across the 18-member bloc performed better than any of the 39 economists polled by Reuters had forecast, while manufacturers also reported a stronger month than suggested by the median Reuters forecast.

Markit said the data suggest quarterly economic growth of 0.4 percent if a similar pace is maintained in August and September.

"There is a very encouraging expansion in the services sector, with Germany growing at its fastest pace in three years and even French companies returning to modest growth," said Chris Williamson, Markit's chief economist.

The rest of the euro zone performed even better, with the largest monthly increase in business activity recorded since August 2007 accompanied by a similar surge in new orders growth.

Yet while euro zone services business expanded at its fastest pace since May 2011 - the PMI rose to 54.4 - firms have now cut prices for 31 months in a row. The sub-index measuring service sector output prices fell to 48.3, despite high raw material costs.

With inflation stuck at 0.5 percent in June, well below the European Central Bank's danger level of 1 percent, that suggests policymakers still face a tough task to thwart the threat of deflation.

"There's so much spare capacity that deflation remains a bigger risk at the moment," Williamson said. "Companies simply cannot push through cost increases to consumers at this point."

Job creation remains a problem, however, with firms barely hiring additional staff in July. The employment sub-index in the services sector was steady at 50.9 in July.

It was also a less positive story for manufacturing business, where growth essentially remained steady at a slow rate, with French factories still reporting a deterioration in conditions while Germany's reporting a slight improvement.

The manufacturing index stood at 51.9, up a tick from 51.8 in June. The output index, which feeds into the composite PMI, edged up slightly to 53.0 from 52.8.

Asked why manufacturing was lagging behind growth in services, Williamson said: "It probably reflects geopolitical concerns, notably the unrest in Ukraine. That's beginning to feed through in the survey responses more and more."