(Adds economist views, market reaction, graphic, details)
* Services PMI at 20-month high, manufacturing 18-month high
* Manufacturing output index at 23-month high
* Composite PMI highest since December 2007
* Services new business index reaches 20-month high
By Jonathan Cable
LONDON, Oct 23 (Reuters) - Euro zone services business grew at its fastest pace in 20 months in October, quicker than expected, while manufacturing activity expanded for the first time in over a year, suggesting the recovery is gathering pace.
Markit's Eurozone Flash Services Purchasing Managers Index (PMI), compiled from surveys of around 2,000 companies, on Friday leapt to 52.3 in October from 50.9 in September, its highest level since February 2008.
That smashed consensus expectations for a rise to 51.4, powered ahead by a leap in services growth in France, and came in a touch higher than even the most optimistic forecast in a Reuters poll of 36 analysts.
"Overall the readings are encouraging. They confirm what we were looking for -- the expansion continues, the mood remains relatively upbeat. I think we are witnessing a normalisation," said Silvio Peruzzo at RBS.
For a graphic showing the euro zone manufacturing and services PMI, click here:
http://graphics.thomsonreuters.com/109/EZ_PMIMSF1009.gif
Markets were little moved on the data, with the euro slightly off a year high of $1.5060 hit earlier on Friday.
The reading for the dominant service sector, above the 50.0 mark that divides growth from contraction for the second consecutive month, will likely reassure the European Central Bank that its loose monetary policies are bearing fruit.
The euro zone economy contracted 0.1 percent in the second quarter of this year, having shrunk by a record 2.5 percent in the first, but economists polled by Reuters last week expect it to have grown 0.4 percent in the third. [ECILT/EU]
The euro zone flash manufacturing index also beat expectations for 50.1 by coming in at 50.7, an 18-month high and up from the 49.3 seen last month. The sector's output index rose to a 23-month high of 54.1, well above September's 51.7.
"Euro zone manufacturing above 50 shows the sector is coping with euro strength. (But) I think the best we can do from here is flatline," said Kenneth Broux at Lloyds TSB.
For a graphic showing the euro zone manufacturing PMI and GDP growth, click here:
http://graphics.thomsonreuters.com/109/EZ_PMIGDP1009.gif
The manufacturing new export orders index rose to a 21-month high of 51.5 this month, up from 50.1 in September, but this could be dented by a strengthening euro.
The euro
"It's undoubtedly having an effect already, export order growth is lagging overall order book growth which suggests that it is the domestic economy within the euro area that is driving the expansion," Williamson said.
"If the exchange rate was more favourable I'm sure the euro area would be seeing stronger growth."
The combined rises in the services and manufacturing indexes took the Composite Index to a 22-month high of 53.0, up from 51.1 in September and above the 51.6 expected by economists.
FRENCH CONNECTION
Separate flash PMIs earlier showed manufacturing sector activity in Germany, the 16-nation bloc's biggest economy expanded for the first time in over a year but its service sector expanded at a far slower pace than expected.
The German services PMI fell to 50.9 this month, down from September's 52.1 and considerably below expectations for a rise 52.5.
The Munich-based Ifo think tank said earlier on Friday that German business sentiment rose slightly this month, pointing to a hesitant recovery in the country.
However, neighbouring France, the euro zone's second biggest economy, saw its services sector expand for the second month -- at a pace not seen in 20 months -- while its manufacturing sector grew for a third, both better than expectations.
Service sector new business across the euro zone reached a 20-month high this month, as orders rose, with the index reaching 51.9, up from the 50.7 seen in September.
But while both sectors are expanding companies are still slashing jobs in a bid to cut costs and the composite employment index remained firmly in contractionary territory at 45.1, although up from September's 44.6.
"This is the one to watch," said Chris Williamson at data provider Markit.
"We need a stabilisation of the labour market to help sustain any recovery next year. Generally the trend is moving in the right direction but it is slower than in other countries such as the U.S. and the UK."
Official unemployment hit a 10-year high of 9.6 percent in August and is forecast to reach 10 percent this quarter and hold above that level into 2011.
Detailed PMI data are only available under licence from Markit and customers need to apply to Markit for a licence. To subscribe to the full data, click on the link below: http://www.markit.com/information/register/reuters-pmi-subscriptions
For further information, please phone Markit on +44 20 7260 2454 or email economics@markit.com (Editing by Andy Bruce)