By Jonathan Cable
LONDON (Reuters) - Business activity in the euro zone has expanded at the fastest pace this year so far in October, as a buoyant Germany offset the impact from firms raising prices at the sharpest rate in more than five years, a survey showed.
The upturn in both activity and prices will make welcome reading for policymakers at the European Central Bank, who left their ultra-loose policy unchanged last Thursday but kept the door open to more stimulus in December.
IHS Markit's euro zone flash composite Purchasing Managers' Index, seen as a good overall growth indicator, jumped to 53.7 from September's 52.6.
It was far above the 50 point line indicating growth in activity and smashed even the highest forecast in a Reuters poll of economists which had predicted a more modest rise to 52.8.
"Good PMI news as the composite index rose to its highest level since December of last year, driven by both manufacturing and services. Higher input prices are filtering through to output prices," Holger Sandte at Nordea said.
However, although Germany's economy outperformed expectations, France's overall private sector activity expanded at a slower pace due to weaker than forecast service sector business.
Germany's composite PMI was also its highest this year, indicating Europe's largest economy is performing well at the start of the fourth quarter after losing momentum in the previous two months.
IHS Markit said, if maintained, the PMI pointed to 0.4 percent euro zone growth in the current quarter, although added there were upside risks to that prediction. A Reuters poll last week predicted a more modest growth rate of 0.3 percent. [ECILT/EU]
Despite years of ultra-loose monetary policy, inflation is nowhere near the ECB's 2 percent target ceiling - it was just 0.4 percent in September - so evidence of rising prices could dampen expectations the ECB extends its massive asset-buying program.
A Reuters poll predicted the ECB would tweak its asset purchase program and announce an extension by year end.
It has already spent over a trillion euros buying government bonds, cut its refinancing rate to zero and adopted a negative deposit rate, besides giving billions of euros in essentially free loans to commercial banks to lend on to customers.
"The ECB will still need to do more to bring inflation back towards its target on a sustained basis across the euro zone," said Stephen Brown at Capital Economics.
A subindex measuring output prices rose to 50.5 from 50.0, its highest since August 2011, but still suggesting relatively weak inflationary pressures.
The bloc's dominant service industry also performed much better than expected. Its PMI came in at a nine-month high of 53.5, ahead of September's 52.2 and beating all forecasts in a Reuters poll where the median call was for 52.4.
New business growth picked up sharply, suggesting the overall acceleration could continue into November. The index registered 53.2, up from 52.5.
Manufacturers followed the same trend. The factory PMI climbed to a 30-month high of 53.3, above the poll median and September's 52.6, while the output index, which feeds into the composite PMI, jumped to 54.4 from 53.8.
Highlighting the confidence about the coming months amongst manufacturers, they increased headcount at the fastest rate since May 2011. The employment subindex was 53.7 compared to September's 52.1.
(Editing by Alison Williams)