LONDON—Shrinking activity levels in Spain and Italy pulled euro-zone businesses closer to a standstill in July, suggesting the economy got off to a poor start in the third quarter.
The composite Purchasing Managers' Index for the 17-nation currency bloc fell to 51.1 in July from 53.3 in June. That is the weakest growth reading in almost two years and puts the private-sector activity nearer to the 50 threshold that separates expansion from contraction.
Private-sector activity in Spain and Italy contracted, with Spain's reading falling to its lowest in a year and a half. Growth in Germany and France slowed to the weakest levels in more than 20 months.
Ken Wattret, senior euro-zone economist at BNP Paribas, said the survey findings are "further evidence of a marked deterioration in economic conditions in the euro zone in recent months."
Mr. Wattret said the composite PMI reading is consistent with quarterly economic growth in the euro zone of around 0.1%, down from around 0.7% in April when the PMI peaked at 57.8.
Official figures for gross domestic product growth in the second quarter won't be available until later in August but some economists say they are likely to mark a sharp slowdown from the 0.8% growth registered between January and March.
The PMI reading on new orders, a forward looking indictor of activity, suggested there is little prospect of a rebound beyond July. That index dropped to 50.4 from 52.4, barely above the no-change threshold. New orders shrank in Spain and Italy and dropped sharply to a near-standstill in Germany.
Silvio Peruzzo, economist at the Royal Bank of Scotland, said it is "a little to early to jump to the conclusion" that the euro zone is heading back toward recession, based on one survey that is still consistent with growth—albeit marginal. He said the European Central Bank is also likely to wait for further confirmation of economic conditions before reassessing its policy stance.
The ECB, which is expected to keep its key interest rate on hold at 1.5% at its latest policy announcement Thursday, has raised borrowing costs twice since April in a bid to curb above-target inflation.
Official data Wednesday also pointed to a fall in retail sales the second quarter, despite a surge in June. Eurostat, the European Union's statistics agency, said retail sales rose 0.9% month-to-month in June, thanks to a 6.3% rise in Germany. But that wasn't enough to fully offset May's 1.3% decline. Emilie Gay, economist at Capital Economics, a consultancy, said this means second-quarter sales were down 0.3% from the previous three months, following a 0.2% fall recorded in the first quarter.
With unemployment high, incomes falling and the ongoing fiscal crisis sapping confidence, consumer spending is unlikely to stage a sustained rally in the months ahead.
Wednesday's PMI and retail sales data provide a particularly alarming snapshot for Spain—a country, alongside Italy, that is at risk of falling victim to the euro zone's ongoing sovereign-debt crisis. Spanish retail sales fell 0.5% in June, following a 1.6% decline in May. July data for Italy aren't yet available.
Fears that Spain and Italy could join the "peripheral" group of troubled euro-zone nations like Greece and Portugal—struggling to pay off debts while imposing harsh austerity programs—have driven market yields on the two countries' debt to record levels.
Italian 10-year bonds yielded 6.227% at one point Wednesday morning, a euro-era high. Spain's 10-year yields hit 6.388%, pushing the spread between them and safe-haven German debt to more than four percentage points, also a record.
