Lending to households and companies in the 17-nation euro area contracted for the first time in more than two years in May as the sovereign debt crisis curbed demand for credit.

Loans to the private sector declined 0.1 percent from a year earlier after gaining an annual 0.2 percent in April, the Frankfurt-based European Central Bank said today. That's the first contraction since March 2010. From April, loans fell 0.1 percent for their fourth straight monthly drop.

“This is not good news,” said Thomas Costerg, an economist at Standard Chartered Bank in London. “There's a lack of demand and a lack of supply, and it's further supporting evidence for an ECB rate cut next week.”

The ECB has injected more than 1 trillion euros ($1.26 trillion) in three-year loans into the banking system in an effort to keep credit flowing during the debt crisis. Economic confidence in the euro area slumped to the lowest in more than 2 1/2 years in June and German unemployment increased more than economists forecast, adding to signs the European economy is shrinking.

Banks tightened credit standards less in the first quarter than in the previous three months, while demand for loans from non-financial corporations and households continued to fall, the ECB said in its quarterly bank lending survey published April 25. The central bank next decides on interest rates on July 5.

The rate of growth in M3 money supply, which the ECB uses as a gauge of future inflation, accelerated to 2.9 percent in May from 2.5 percent in the previous month.

M3 grew 2.8 percent in the three months through May from the same period a year earlier, the ECB said. M3 is the broadest gauge of money supply and includes cash in circulation, some forms of savings and money-market holdings.

“While there may be some demand for loans in the German housing market, in the periphery demand is very weak,” said Carsten Brzeski, senior economist at ING Belgium SA in Brussels. “In the current circumstances it's hard to expect a great spur to loan growth.”

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Euro-Area Lending Contracts

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