(Recasts with new headline, adds market reaction)
By Jonathan Cable
LONDON, March 24 (Reuters) - Key euro zone services and manufacturing indexes rose in March but analysts warned the economy may see a sharper contraction in the first quarter than the 1.5 percent it shrank in the last three months of 2008.
Markit said on Tuesday its Flash Eurozone Purchasing Managers Index for the dominant service sector rose to 40.1 in March, well below the 50 mark where growth begins but ahead of February's 39.2 and considerably above expectations for 39.0.
Factories in the euro zone also saw a slowing in the rate of decline with the flash Manufacturing PMI rising to 34.0 from 33.5 in February and above the 33.4 expected by economists.
However, the PMI levels were still below readings seen in the last months of 2008, leading many analysts to conclude that any significant slowing in the pace of deterioration would not come until the second quarter. "Overall I think the picture is remaining very bleak," said Silvio Peruzzo at RBS. "They are still pointing to an accelerating pace of contraction in the economy. I think the GDP numbers for the first quarter will be pretty weak."
The euro pared some of its losses after the data were released while European shares traded only modestly up following an explosive rally on Wall Street on Monday.
The European Central Bank has slashed interest rates as it battles to breathe life into an economy that Reuters polls predict will contract 2.6 percent this year. It is widely expected to cut again later this week.
A string of economic institutes have cut their forecasts for 2009 German GDP, the 16-nation bloc's largest economy, over the last week with Commerzbank saying it expects GDP to fall between 6 and 7 percent this year, easily the most gloomy of forecasts.
German corporate sentiment is expected to have declined further from February's near 20-year low when the Ifo economic research institute releases March figures on Wednesday.
Data released earlier showed French shoppers cut spending at the fastest pace in over a year in February while business confidence stuck at record lows in March as job losses mounted.
"The hard data paint a more depressing picture and show that the export and industrial downturns gathered pace at the start of this year. Accordingly, GDP could easily contract by another 1.5 percent (quarter-on-quarter) in Q1," said Ben May at Capital Economics.
RAY OF LIGHT
The upturn in both sectors took the combined Composite index to 37.6 from February's 36.2 and above the 36.0 which had been predicted, as global efforts to combat recession by boosting government spending and cutting borrowing costs begin to help.
"The rise in March provides an early indication that the pace of contraction will ease in Q2 after the breathtaking nosedive in activity that we saw at the end of last year and the first few months of this year," said Nick Kounis at Fortis.
Service sector firms were a little less pessimistic about the 12-month outlook with the business expectations index rising to 47.5 from February's 46.1.
And the fall in new manufacturing orders was also a little less steep, with that index rising to 30.7 from 28.2 in February, while the stocks of finished goods index slumped to a record low, suggesting firms were managing to shift old stock.
Even so, companies battling against sinking demand and banks' reluctance to lend have been forced to slash jobs to cut costs and stay afloat.
The Composite employment index, which measures employment broadly in the euro area, dropped to 40.3, a record low for the 10-year-old index, from 40.8 in February.
Expectations of another ECB rate cut will be reinforced by data showing input price pressures across the bloc fell to record lows and companies passed on their savings to customers, slashing their prices at a record pace. (Editing by Mike Peacock)