RaboResearch - Economic Research

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Eurozone: Second wave delays economic recovery

Economic Quarterly Report

  • The Eurozone economy is set to contract in the final quarter of the year, after the strong rebound in Q3
  • Over the course of the first quarter in 2021 the recovery is likely to pick up again
  • We forecast the Eurozone economy to contract by 7.4% in 2020, followed by a modest growth of 3.9% in 2021
  • The degree to which governments are willing and are able to continue stimulus throughout the next year is an important determinant for growth in individual Eurozone countries
  • Considerable uncertainty remains about the underlying damage done to companies in the COVID-19 crisis
  • Funds from the European recovery fund could become available next year, but there are still some hurdles to take

Recovery in Q3, to be followed by contraction in the fourth quarter

In the third quarter, Eurozone GDP grew 12.6 percent quarter-on-quarter (Figure 1), leaving it 4.4 percent below its pre-crisis level. The rebound was sharper than many had anticipated. Yet the nascent recovery was short-lived. All over the Eurozone, new lockdown measures have been implemented in recent weeks to curb the second wave of the pandemic. Most countries have closed the hospitality sector, while Belgium and France have even closed all non-essential shops. Italy and Spain are taking a regional approach. At the time of writing, in both countries about half of the regions (based on their contribution to national GDP) have shut hospitality venues, and less than one-fifth have also closed non-essential shops. Meanwhile, all over Europe, most schools and factories are still open. An overview of the measures in the largest four countries can be found in Table 2 (end of publication). All in all, while some countries have imposed measures just shy of the draconian lockdown of the second quarter, so far the measures put in place in most countries are less strict than during the first wave (Figure 2).

Figure 1: GDP rebound in Q3 surprises on the upside, but Q4 outlook is weak
Figure 1: GDP rebound in Q3 surprises on the upside, but Q4 outlook is weakSource: Macrobond, RaboResearch
Figure 2: Tougher containment measures still fall short of April levels
Figure 2: Tougher containment measures still fall short of April levelsSource: Macrobond, University of Oxford

Accordingly, we expect the Eurozone economy to contract in the final quarter of the year, but not nearly as much as in the first half of the year (Figure 1). Not only are domestic containment measures less strict, but manufacturing production is also not suffering from the global supply chain disruptions that plagued the first half of the year. Finally, we expect rather strong demand in several important non-Eurozone trading partners, such as the US and China, which could help to mitigate the slump in intra-Eurozone trade. We forecast the Eurozone economy to contract by 2.4 percent in Q4 vis-à-vis the third quarter.

Vaccine will fuel recovery in 2021

Looking beyond the fourth quarter-setback, there is also some positive news. Multiple pharmaceutical companies are in the final stages of developing a vaccine, and the effectiveness of these vaccines has exceeded expectations. Our baseline is that a vaccine will start to be administered to the elderly and vulnerable over the course of 21Q1. Consequently, restrictions could be loosened broadly to the level of last summer in the second quarter. However, we believe that substantial loosening beyond that level will only happen in the second half of 2021, given the time it will take to vaccinate a broad swathe of the population. Against this backdrop, we expect rather strong growth already in the second quarter, pushing GDP back to the level of 20Q3 in 21Q2, with another significant jump in GDP in the second half of 2021. Thereafter, we expect that the recovery will continue, albeit at a more gradual pace.

Figure 3: Recovery differs per sector
Figure 3: Recovery differs per sectorSource: Macrobond, RaboResearch

We forecast the Eurozone economy to contract by 7.4 percent in 2020 and to grow by 3.9 percent in 2021 (Table 1). This implies that the economy will still be some 2 percent smaller at year-end 2021 than year-end 2019. However, the economic damage will not be equally distributed across countries and sectors. Whereas some sectors have been left relatively unscathed or are already close to recovering their losses, other sectors still have a long way to go (Figure 3 and Table 3). We expect bankruptcies to rise as the malaise in certain services sectors continues in the coming months; government support will gradually be wound down in the coming year (see below); and the economy will be forced to adjust to a ‘new normal’. We forecast unemployment to rise in 2021 as well. Although job retention schemes have proved to be very effective at containing an increase so far, in several countries support is projected to be wound down over the coming year[1]. Not all people currently in the schemes can be expected to be put on ‘their’ company’s payroll once again. Especially companies in hard-hit sectors will have to cope with weakened balance sheets and, as mentioned, we expect bankruptcies to rise still. We forecast unemployment to decrease over the course of 2022 but to remain above its 2019 level for some years: we think it will take time before workers who lost their jobs in hard-hit sectors such as hospitality and tourism to find a new job in their current sector or be retrained and employed in other sectors.

Table 1: Growth Forecast for the Eurozone
Table 1: Growth Forecast for the EurozoneSource: Macrobond, RaboResearch

Fiscal response to the second wave

Alongside the measures put in place to contain the spread of the virus, governments are likely to come up with additional fiscal support to mitigate the economic damage. For example, several governments have already announced an extension of job retention schemes. But member states are reluctant to extend the massive spending of 2020 into 2021. Firstly, because they do not expect similar lockdowns that harm economic activity in 2021. Second, because they are not willing to risk their creditworthiness unnecessarily, either now or in the future (although the ECB is doing everything in its power to prevent yields from rising, there is no guarantee this will go on forever). This holds in particular for Spain and Italy who’s already weak public finances have substantially deteriorated further. Third, governments seem to have learned from the past year, inducing them to introduce more targeted support measures rather than blanket support.

The additional support will therefore focus mostly on sectors and workers that have been directly affected by the containment measures, on extending furlough schemes, and on delaying deadlines for tax payments. Since companies in Europe are very reliant on banks for financing, we would also expect governments to step up their loan guarantees if necessary to make sure that the crisis does not lead to a credit crunch, especially since banks are signalling a tightening of lending standards (although banks are nowhere as strict as during the GFC). Yet so far it seems that in most countries, with Spain as a possible exception, there is still plenty firepower left in terms of loan guarantees. In Germany for example, around EUR 40bn of EUR600bn in loan guarantees has been used so far.

Additional support from Europe?

The European Union has already deployed a number of tools to mitigate economic damage and to speed up the recovery. The focus for now will most likely be on enabling these funds to find their way to the right recipient as soon as possible and not on new crisis support measures. The tools include the SURE fund (EUR 100bn), which gives member states access to cheap loans to finance measures to preserve employment (such as short-time work schemes). Furthermore, extra funding is available for mostly small and medium-sized companies via the European Investment Bank (EIB, EUR 200bn) in the form of loan guarantees. Additionally, the European Stability Mechanism (ESM) has created a Pandemic Crisis Support programme (EUR 240bn), which offers cheap credit lines to member states with the sole condition that such funds are spent on tackling the health crisis. Finally, in July a provisional agreement was reached on the Next Generation EU fund (NGEU), also known as the EU’s crisis recovery fund, totalling EUR 750bn, to be disbursed to member states in the form of grants and cheap loans between 2021 and 2026. So far, the SURE fund has made most progress. Over 90 percent of the total fund has already been committed and some 40 percent has already actually been disbursed.

The EIB’s and ESM’s crisis funds are still lying idle but are ready to be used. Only EUR 21bn of the EUR 200bn available from the EIB’s pandemic response package has been granted so far[2], while no country has yet applied for funds from the ESM. Meanwhile, the Next Generation EU fund still has some serious hurdles to overcome. Poland and Hungary have been blocking its implementation in a bid to push the EU to drop or substantially water down a new rule-of-law mechanism that was adopted in early November. This mechanism, projected to come into effect next year, is supposed to block transfers of EU funds to countries disrespecting the rule of law in a bid to protect EU taxpayers against the misuse of EU funds.

On 9 December, a provisional agreement on changing the regulation was said to have been reached between Poland, Hungary and the German presidency of the Council. At the time of writing, the details of the provisional agreement have not yet been made public. Agreement over altering the mechanism is also still not definitive, given that both a qualified majority of Member States and the European Parliament also need to approve the compromise proposal. The issue is said to be tabled in the European Council meeting of 10 December. Going forward, if a final agreement on the mechanism and the multiannual budget will be reached in December, the NGEU could come into force over the course of 2021. The first small amount of funds should then be expected to flow late 2021. Yet if a compromise appears to be out of reach and the spat between Poland/Hungary and the rest of the EU turns into a very serious split, implementation of the EU budget and the NGEU could be derailed. This would result in a significant amount of lost income via EU funds for recipient member states. In turn this could dent confidence and economic recovery in the EU, especially in hard-hit member states with weak public finances such as Italy and Spain.

The NGEU and our baseline forecast

In our baseline forecast we have incorporated the downward effect that the provisional agreement on the NGEU in July has had on interest rates, but not the possible economic impact of the grants that are supposed to be disbursed to EU member states between 2021 and 2026. While we expect that, after some delay, some compromise or work around will be found, implementation of the recovery instrument is still not a given. The proposal includes a grant component of EUR 390bn (2.8 percent of GDP) for the entire EU. When the deal goes through, there is an upward potential for GDP growth, especially from 2022 onward. That said, in the event of a standoff in Brussels, rising bond spreads could dent our forecast, although ECB actions would likely put a lid on such spread widening.

When the dust settles

Our economic projections are for a gradual economic recovery that gains pace in the course of 2021 on the back of a wind-down of containment measures. But only then will we be able to see the true damage (and costs) of Covid-19. We have already highlighted the expected rise in bankruptcies and unemployment that will act as a brake on the recovery in 2021. Another matter is the huge debt-pile that stems from the Covid-19 crisis and the ongoing support from the ECB that will be needed to prevent second-round effects on markets and a tightening of financial conditions. The legacy of three crises in 13 years does not make for a great outlook when the dust finally settles.


Table 2: Containment measures in the Eurozone 8 December
 Table 2: Containment measures in the Eurozone 8 DecemberSource: RaboResearch, National governments
Table 3: Year-to-date change in total value added and weight in total economy per sector
Table 3: Year-to-date change in total value added and weight in total economy per sectorSource: Macrobond, RaboResearch


[1] While the furlough scheme is projected to run until end-2021 in Germany, the current end-date is end-January 2021 in Spain, for example.

[2] It is unclear why this is the case, but it could be due to the adequacy of national support or a reluctance of companies to take on extra debt.


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