Europe’s economies shrank less than expected at the end of 2020, despite the second wave of coronavirus infections turning into a third wave. As this will push out the anticipated recovery in household spending, we’ve cut our growth forecasts but are now looking for a bigger improvement in 2022.
The European Central Bank had expected eurozone GDP in the fourth quarter of 2020 to be 2.2 per cent lower than the previous three months. In fact, the contraction was just 0.7 per cent. Spain and Germany even grew slightly.
France’s 1.3 per cent quarterly contraction was the biggest upside surprise but still probably tipped it into double-dip recession as lockdown turned into increasingly tougher curfews. Household consumption fell 5.4 per cent between the third and fourth quarters but investment expanded by 2.4 per cent, with services investment up 7.1 per cent on the back of a buoyant housing market. House price inflation and transaction numbers both picked up through the pandemic.
The unusual nature of the COVID-19 recession means that investment has fallen less and recovered faster than in typical downturns. After the 2008 financial crisis banks de-levered and credit conditions tightened; this time the housing market has been fairly strong across Europe, reflecting low borrowing costs, the pandemic-induced ‘race for space,’ and lower-income households that are not owners bearing the brunt of unemployment and reduced pay.
And IT investment has held up. Working from home has meant systems need upgrading or to be made more robust.
The higher-than-expected 2020 base, alongside extended and stricter restrictions this year, mean we think eurozone GDP will contract again in the first quarter of 2021, giving a technical double-dip recession. We expect significant contractions in France and Germany with flat growth in Italy while Spain records another modest expansion.
Ongoing restrictions and the EU’s relatively slow vaccine roll-out mean the consumption bounce-back is likely to be delayed again. However, eurozone households saved around EUR470 billion ore in 2020 than in 2019 - equivalent to almost 4 per cent of GDP - and spending growth doesn’t need consumers to spend that, merely to save less this year.
We now forecast eurozone growth of 3.6 per cent in 2021, down from 4.3 per cent previously, due to a weaker first-half, but we’ve revised up 2022 growth to 3.5 per cent from 3.1 per cent. The net effect is that we still think eurozone output at the end of 2022 will be about 2 per cent below the pre-pandemic trend. But much shallower previous recessions have typically left larger scars.
The new forecasts still imply an uneven recovery. Germany will be almost back to pre-pandemic output by this December while Spain’s recovery could be much slower, partly because the service sector and tourism will take time to return to 2019 levels. Italy’s closed ski resorts - which generate about 0.6 per cent of its GDP - will affect its growth.
Eurozone core inflation hit an all-time low of 0.2 per cent in December but could briefly reach 2 per cent this year. The flirtation with its target is likely to be short-lived however, and should not prompt any let up in monetary easing.
First published 8 February 2021.
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