LONDON A downturn in euro zone business activity deepened much more than expected in July as demand in the bloc's dominant services industry declined while factory output fell at the fastest pace since COVID-19 first took hold, a survey showed.

HCOB's flash Composite Purchasing Managers' Index (PMI) for the bloc, compiled by S&P Global and seen as a good gauge of overall economic health, dropped to an eight-month low of 48.9 in July from June's 49.9.

That was below the 50 mark separating growth from contraction and lower than all expectations in a Reuters poll which had predicted a modest dip to 49.7.

"Manufacturing continues to be the Achilles heel of the euro zone. Producers have cut their output again at an accelerated pace in July, while the services sector's activity is still expanding, though at a much slower rate than earlier in the year," said Cyrus de la Rubia, at Hamburg Commercial Bank.

"The euro zone economy will likely move further into contraction territory in the months ahead, as the services sector keeps losing steam."

The services PMI fell to 51.1 from 52.0, its lowest since January and shy of the Reuters poll forecast for 51.5.

Indebted consumers feeling the pinch from rising borrowing costs and prices cut back on spending, and the services new business index went below breakeven for the first time in seven months. It was 48.5 this month and 51.0 in June.

A PMI covering the manufacturing sector dropped to 42.7 from 43.4. The Reuters poll had forecast a slight rise to 43.5.

An index measuring output, which feeds into the composite PMI, fell to 42.9 from 44.2 - a low not hit in over three years.

The decline came despite manufacturers running down backlogs of work and cutting their prices. Factories benefited from a sharp drop in input costs due to falling demand for materials and improved supply. The sub index fell to 35.5 from 39.5, its lowest in 14 years.

Easing price pressures will probably be welcomed by policymakers at the European Central Bank who have failed to get inflation back to their 2% target despite implementing the most aggressive policy tightening schedule in the Bank's history.

They will raise interest rates by 25 basis points on Thursday, according to all economists in a Reuters poll, a slight majority of whom expect another hike in September.

(Reporting by Jonathan Cable; editing by John Stonestreet)