Unexpected drop in euro zone output clouds recovery hopes

By Martin Santa

BRUSSELS (Reuters) - Euro zone industrial production contracted unexpectedly in June, hurting hopes for a stronger recovery as the region feels the effect of conflict in Ukraine, Iraq and and Gaza.

Factory output fell 0.3 percent on the month in June after a 1.1 percent drop in May, data showed on Wednesday, compared with market expectations of a 0.3 percent rise.

Production was flat compared with a year ago, after rising an upwardly revised 0.6 percent rise in May. Economists polled by Reuters had forecast a 0.1 percent annual increase in June. The annual reading was the lowest since August 2013.

"This is a very disappointing figure after the already strong contraction in May," said Peter Vanden Houte, chief euro zone economist at ING.

The monthly drop was caused mainly by a 1.9 percent drop in production of non-durable consumer goods, down for a second consecutive month, and a 0.7 percent decline in energy production, which was up in the previous three months.

A recovery by the 9.6 trillion-euro economy is struggling to gain momentum a year after exiting a recession. High unemployment, sluggish reforms and the fallout from conflict in Ukraine, Gaza and Iraq are holding it back.

The latest sign of just how fragile the euro zone's economic rebound remains came from Germany on Tuesday, where investor sentiment dove to its lowest since December 2012 on concern about the impact European sanctions against Russia will have.

Eurostat will publish a flash estimate of second-quarter economic growth on Thursday. Economists had expected expansion of 0.2 percent on the quarter in the three months to June, the same pace as seen in the first quarter.

"A growth figure of 0.2 percent now seems to be out of reach," Vanden Houte said. "With the geopolitical tensions not cooling down for the time being, there is little likelihood that the growth pace will accelerate in the second half of the year."

While the bloc's three largest economies saw production rising on the month in June, Germany's industrial output fell 0.4 percent year-on-year in June in the country's first annual drop since July 2013.

The region's second-largest economy, France, saw flat output on the year in June, its best performance since December. Italy's industrial production rose by 0.4 percent in June after a 1.7 percent decline in May. But much stronger expansion is needed to create jobs and rejuvenate struggling economies.

Poor economic health will get the attention of the European Central Bank. It is already expected to keep interest rates near their record lows for an extended period, to nurse the economy along, but large-scale quantitative easing is not looked for yet.

"Big decisions on more unconventional policy measures will have to await 2015," added Vanden Houte.

(Additional reporting by Monica Ulmanu in London, Editing by Louise Ireland, Larry King)