Shrinking eurozone economy ratchets up crisis

PMI survey points to deepening contraction, while survey of Madrid banks calls for €62bn recapitalisation

The eurozone remains on course to sink into recession, a key survey of activity across the 17-nation currency zone showed yesterday. Markit's Composite Purchasing Managers' Index (PMI) for the euro area remained at 46 in June for the second consecutive month, with any figure below 50 signalling a contraction.

There were also further indications that the sovereign debt crisis is dragging down the continent's most powerful economy, Germany. The Composite PMI reading for Germany fell to 48.5 this month, down from 49.3 in May. This is the lowest level of the index in three years.

"The downturn is gathering pace and spreading across the region, with Germany on course for a marginal fall in GDP in the second quarter," said Markit's chief economist Chris Williamson. "Firms are preparing for conditions to worsen in the coming months, with the darker outlook often attributed to uncertainty caused by the region's ongoing economic and political crises."

In an indication of rising official concern at the pace of the downturn in the eurozone, there were unconfirmed reports last night that the European Central Bank is preparing to loosen its collateral rules when lending to private banks. The ECB has come under growing pressure to cuts it 1 per cent interest rates at its next meeting to support the currency bloc's economy.

The weak survey data formed a bleak backdrop to a meeting of eurozone finance minister in Luxembourg to discuss a bailout for the Spanish banking sector that was agreed in principle last weekend. The Spanish economy minister, Luis de Guindos, said that Madrid will apply for a formal request for assistance "in the coming days".

An audit of the sector by consultants Roland Berger and Oliver Wyman last night revealed the sector will require between €51bn (£41bn) and €62bn in the event a serious slump. But Spain is expected to request €100bn in loans from European partners to recapitalise its banks. Mr de Guindos said: "We have already started working on the design of the aid with the Commission, the European Central Bank and the International Monetary Fund".

Italy and Spain pushed this week for Europe's leaders to allow the Continent's bailout funds to buy their sovereign bonds directly in the secondary debt markets. And the two nations borrowing costs have eased in response to reports that Germany might be willing to approve such assistance.

Madrid's benchmark 10-year bond yields fell to 6.6 per cent yesterday, while Italy's interest rates closed lower at 5.75 per cent. However, there remained signs of investor fears as Spain was forced to pay 6.1 per cent at an auction to offload five-year debt, up from 4.96 per cent in May.

The leaders of Spain, Italy, France and Germany will meet in Rome today, ahead of next week's formal EU leaders' summit in Brussels. Under discussion will be the bond purchase proposal and a pan-European banking union.

The eurozone narrowly managed to avoid a return to recession earlier this year, after registering 0 per cent growth in the first quarter after a 0.3 per cent contraction in the final quarter of 2011. But Spain and Italy are now back in recession and Greece is in its fifth straight year of contraction.