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UPDATE 3-Euro zone business growth hits three-year high but ECB cautious

(Adds consumer confidence data)

LONDON, May 21 (Reuters) - Euro zone business growth accelerated at its fastest pace in over three years in May, a survey showed on Friday, but European Central Bank President Christine Lagarde said an uncertain recovery still needed emergency support from the ECB.

After a slow start to vaccinations the pace is picking up, allowing some restrictions imposed to quell the spread of the coronavirus to be lifted, and a strong resurgence in the bloc’s now-reopening service industry added to the impetus from a booming manufacturing sector.

As the economy rebounds and confidence improves, some policymakers are making the case for the ECB to start giving up its emergency measures and revert to more traditional forms of stimulus.

But others are more cautious, warning the fledgling recovery is predicated on copious ECB support and that a recent rise in borrowing costs to two-year highs is already a major drag.

“We are committed to preserving favourable financing conditions. It’s far too early and it’s actually unnecessary to debate longer-term issues,” Lagarde said on Friday.

“I have repeatedly said that policymakers needed to provide the right bridge across the pandemic, well into the recovery, so we can actually deliver on our mandate.”

Alongside that, euro zone finance ministers will continue to support their economies but were upbeat on Friday about prospects for the post-pandemic recovery.

With more businesses reopening - or at least adapting to lockdowns - IHS Markit’s flash Composite Purchasing Managers’ Index, seen as a good guide to economic health, climbed to 56.9 in May from April’s final reading of 53.8.

That was its highest level since February 2018 and comfortably above the 50 mark separating growth from contraction, as well as the more modest increase to 55.1 predicted in a Reuters poll.

“We don’t think today’s euro area PMI data will cause the ECB to taper the PEPP next month,” said George Buckley at Nomura.

The bloc’s economy will expand 1.4% this quarter, according to a Reuters poll last week that also found forecasts for the rest of the year had been downgraded from last month.

“May’s increase in the euro zone Composite PMI reflects the further lifting of virus restrictions in many parts of the region and suggests that the economic recovery is now underway,” said Jessica Hinds at Capital Economics.

In Germany, Europe’s largest economy, services activity rose by the most in nearly a year, helped by a loosening of restrictions. But supply bottlenecks in manufacturing led to production problems at a growing number of factories.

The lifting of a lockdown in France unleashed a business boom there, with activity surging past expectations to set the stage for an economic rebound.

A deal agreed by the European Union on Thursday to open up tourism across the 27-nation bloc this summer should provide a boost to tourism-dependent economies that were hammered by restrictions last year.

INFLATIONARY PRESSURES

A preliminary PMI covering the 19-country euro zone’s dominant service industry bounced to 55.1 from April’s 50.5, well above the 52.3 median forecast in the Reuters poll and its highest since June 2018.

Services firms benefited from the release of pent-up demand. The new business index - which has been below 50 almost throughout the pandemic - soared to 56.7 from 49.7, its highest since January 2018.

The manufacturing industry has weathered the coronavirus crisis much better than services as factories largely remained open. Its flash PMI dipped from April’s record high of 62.9 to 62.8 but was ahead of the 62.5 Reuters poll estimate.

An index measuring output that feeds into the composite PMI dropped to 61.9 from 63.2.

But supply-side issues have made it a seller’s market for purveyors of raw materials and factories faced a record increase in input costs. The sub-index soared to 86.5 from 82.2, its highest since the survey began in June 1997.

“The combination of demand returning quickly for services and input shortages emerging are creating a perfect environment for surging pipeline inflation,” said Bert Colijn at ING.

Hopes the vaccine rollout is successful and that the worst of the pandemic is behind the bloc pushed overall optimism to its highest since IHS Markit began collecting the data in July 2012. The composite future output index rose to 69.7 from 68.9.

Consumer confidence in the bloc improved more than expected this month, official data on Friday showed. (Reporting by Jonathan Cable; Editing by Catherine Evans)

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