By Devik Jain and Amruta Khandekar
(Reuters) -European shares dropped on Wednesday, snapping a three-day rally as investors tempered expectations of central banks toning down their hawkish stance on inflation, with declining business activity in the region fuelling fears of an economic downturn.
After rallying more than 5% in the previous three sessions, the pan-European STOXX 600 index was down 1% as a sharp rate hike from New Zealand's central bank on Wednesday jolted investors and weighed on risk sentiment.
The index had logged its best one-day performance since mid-March on Tuesday after weaker U.S. manufacturing data, shrinking U.S. job openings and a smaller-than-expected rate hike from the Reserve Bank of Australia spurred hopes that central banks globally could shift to less-aggressive rate hikes in future.
"(Today) is a realisation that it's still too early to conclude the pivot is coming," said Azad Zangana, senior European economist and strategist at Schroders (LON:SDR).
Employment data from the United States on Wednesday did little to allay jitters about rate hikes. U.S. private employers stepped up hiring in September, while the Institute for Supply Management's services industry employment gauge also shot up, suggesting strong labour demand.
Investors are now waiting for a more comprehensive U.S. nonfarm jobs report due on Friday for further clues on the state of the labour market and whether the Federal Reserve could pivot from its current ultra-hawkish approach.
Meanwhile, the latest data showed euro zone business activity contracted for a third month in September, dashing any hopes the currency union will avoid recession.
"I think Europe is falling into quite a steep recession," said Patrick Armstrong, chief investment officer at Plurimi Wealth. "You've got a consumer who's being pulled by utility bills and petrol prices...Manufacturing is going to slow a lot as electricity prices go up."
The STOXX 600 index has fallen 18.2% so far this year as the region grapples with an energy crisis exacerbated by the Russia-Ukraine conflict and concerns about an economic downturn with agg ressive policy moves by the U.S. Fed and other central banks.
Nearly all STOXX 600's sectoral indexes fell, led by real estate stocks and retailers. Telecom stocks and banks fell 2.2% and 2.1% respectively.
London's blue-chip FTSE 100 was off 0.5% while the more domestically oriented FTSE 250 was down 1.5%.
Among single stocks, Tesco (LON:TSCO) slid 4.1% after Britain's biggest retailer forecast full-year profit at the lower end of its previous guidance.
Shares of Bachem Holding AG gained 2.2% as the biotech supplier floated plans to build a third site in Switzerland.