The downturn that began in the smaller periphery members of the 17-nation bloc is now sweeping through Germany and France and the situation remained dire in the region's third and fourth biggest economies of Italy and Spain.

"Larger nations like France and Germany remain in reverse gear... the (manufacturing) sector is on course to act as a drag on gross domestic product in the third quarter," said Rob Dobson, senior economist at data collator Markit.

Markit's final Purchasing Managers' Index (PMI) for the manufacturing sector fell from an earlier flash reading of 45.3 to 45.1, above July's three-year low of 44.0, but notching its 13th month below the 50 mark separating growth from contraction.

"The rate of decline was a little slower than in July, providing some heart that the manufacturing downturn may be easing, but the sector is on course to act as a drag on gross domestic product in the third quarter," Dobson said.

Having contracted 0.2 percent in the three months to June the bloc's economy is seen posting similar results in the current quarter, with no growth expected until the start of next year.

In its battle to support an economy ravaged by a two-and-a-half-year-old debt crisis, the European Central Bank is now widely seen cutting interest rates to a new record low of 0.5 percent - either on Thursday or next month.

Inflation jumped more than expected in August, data showed on Friday, a factor that may discourage the ECB from acting this week, but the PMI survey showed factories had cut the prices of their products for the third straight month.

The output prices index fell from the flash reading of 48.9 to 48.6, above July's 48.3. The input costs paid by factories also fell for the third month.

CORE CONCERN

Factories in Germany, Europe's largest economy, and France - the second biggest - saw activity fall for the sixth consecutive month although both saw an easing in the decline.

In Italy the main index (43.6) has now been below the break-even point for over a year and was worse than economists had predicted while in Spain it has been sub-50 since May last year.

The latter two countries are deep into austerity programs which are aimed at bringing their debt piles under control but also keep their economies stuck in recession.

They are looking for the European Central Bank help them escape this vicious circle by buying debt issued by their governments to bring down borrowing costs.

"The national picture remains one of widespread contraction, only Ireland saw manufacturing output rise. The situation in Italy is also becoming more of a cause for concern, as it falls further down the PMI league table," Dobson said.

The output index for the sector, which drove a large part of the bloc's recovery from the last recession came in at 44.4, below a flash 44.6 but above July's 43.4.

With the situation still gloomy factories reduced their headcount for the seventh month running. Official data released on Friday showed unemployment across the bloc in July held steady at June's record high of 11.3 percent.

General Motors Co's (GM.N) ailing German unit, Opel, has said it will cut the hours of several thousand workers at two of its four plants and France's struggling carmaker PSA Peugeot Citroen (PEUP.PA) is cutting over 10,000 jobs.

(Editing by Toby Chopra)

• A Permanent Economic Emergency