RaboResearch - Economic Research

Eurozone economy enjoys technical rebound, but outlook is weak

Economic Report

  • The Eurozone economy grew by 12.7% q/q in the third quarter. The German, French, Italian and Spanish economy grew by 8.2%, 18.2%, 16.1%, 16.7% q/q respectively
  • Despite the fact that there was a strong economic rebound, economic activity is still substantially lower than pre-crisis levels
  • Furthermore, different sectors show a different recovery trajectory
  • Some service sectors are still operating much more below capacity as when compared to retail sales and most manufacturing sectors
  • A second round of lockdowns is set to aggravate the damage in the hard-hit sectors, increasing the differences between sectors
  • The Eurozone recorded the third month of consecutive deflation, increasing pressure on the ECB to come with additional stimulus
  • Going forward, we deem it unlikely that economic activity in the coming quarters will be higher than in the third quarter

Historic rebound

After the implosion of the Eurozone economy in the second quarter, unprecedented in times of peace, the third quarter has broken records on the positive side. The Eurozone economy rebounded by 12.7% q/q, whereas the economy of Germany, France, Italy and Spain expanded by 8.2%, 18.2%, 16.1% and 16.7% respectively, compared to the previous quarter (figure 1). Even though these figures compensate for a substantial part of the economic damage in the second quarter, the economy is far from out of the woods yet (figure 2). Especially the services sector still has a large recovery to run. Moreover, now that the second wave of infections has hit Europe, a part of this economic recovery will probably be undone in the current quarter. Hence, despite strong growth in Q3, there is little reason for celebration.

Figure 1: Economy strongly rebounds in Q3…
Figure 1: Economy strongly rebounds in Q3…Source: Macrobond, National Statistical Offices
Figure 2: But is still much smaller than pre-crisis
Figure 2: But is still much smaller than pre-crisisSource: Macrobond, National Statistical Offices

Back to the way it used to be?

After the strict lockdowns of the second quarter, Europeans heaved a sigh of relief and went out to spend money they saved during the lockdown, where possible. Consequently, retail sales strongly rebounded and some countries even recorded a positive y/y growth in retail sales over the course of Q3 (figure 3).

Meanwhile, the re-opening of factories in Italy, Spain and France and the fading of supply chain issues helped the manufacturing sector in ramping up production. Industrial production has not rebounded as strongly as retail sales, but the sector managed to make up a considerable part of the loss (figure 4).

Figure 3: Retail sales showed y/y growth in some countries
Figure 3: Retail sales showed y/y growth in some countriesSource: Macrobond, National Statistical Offices
Figure 4: Industry output partially rebounds
Figure 4: Industry output partially reboundsSource: Macrobond, National Statistical Offices

That said, there are still ongoing concerns as there is no vaccine yet and several containment measures have remained in place  around the globe. Consequently, certain sectors continue to trail others in terms of post-crisis recovery.

More specifically, looking at sales, for example, we see that car sales still have more losses to recover than retail sales. And within manufacturing, car production underperforms several other categories. This partly explains Germany’s relatively weak performance in industrial production when compared to other member states (figure 4) – both because the German car sector underperforms its peers and because it has a large share of car manufacturing in its overall industrial production.

Even more noticeable is the trailing recovery in the hospitality and the arts and recreation sector, as is evident from different national data series. The differences between sectors’ recovery trajectory is broadly comparable between member states. Hence, those member states with a larger share of hard-hit sectors, such as Spain, will take longer to recover.

Unfortunately, new troubles have arisen before all crisis losses have recovered.  The second virus wave in Europe came ‘ashore’ mid-summer in Spain and by now has reached all countries – albeit in different intensity (figure 5). Containment measures have tightened significantly over the past weeks, with France to be the first to go into a full lockdown. While companies will have learnt from the first lockdown to adapt and measures are still less stringent than during the lockdown in Q2 (figure 6) – factories, construction sites and most schools are still open in all countries for example, and apart from France people are not confined to their homes yet – the already hardest-hit sectors will remain restrained the most by the tightened social distancing measures and precautionary behaviour of citizens.   

On a higher level of aggregation, the same holds for countries. Even though no country will be spared in Europe, Spain especially should brace itself for a significant second blow to its economy given its economic structure.

Figure 5: Second wave outpaces the first wave
Figure 5: Second wave outpaces the first waveSource: Macrobond, RaboResearch, WHO
Figure 6: Containment measures are being tightened
Figure 6: Containment measures are being tightenedNote: Index for France and Italy is not yet fully updated with latest data. In Germany new restrictions come into force 1 November.
Source: Macrobond, University of Oxford.

Deflationary headaches

Despite the economic recovery in the third quarter, inflation did not follow suit. The Eurozone recorded its third consecutive month of year-on-year deflation (figure 7). Prices of energy and services were the main culprits, dragging down inflation substantially or contributing significantly less to inflationary pressure than before. The deflationary pressure gives the ECB considerable headaches, since the reasons for this disinflationary or even deflationary trend, the pandemic, is unlikely to go away any time soon. Moreover, with the resurgence of the virus in the Eurozone and subsequent weaker economic recovery, temporary tax cuts in Germany, low oil prices and risks regarding a no-deal Brexit, inflation is unlikely to return to the ECB’s target any time soon.

Figure 7: Eurozone records the third consecutive month of deflation
Figure 7: Eurozone records the third consecutive month of deflationSource: Macrobond, Eurostat
Figure 8: An expensive euro adds to the deflationary pressure
Figure 8: An expensive euro adds to the deflationary pressureSource: Macrobond, ECB

To add to the already dire situation, the euro has gained significant ground (figure 8). A stronger euro results in cheaper imports and thus lower import inflation, while simultaneously weakening economic recovery through putting a lid on exports. For now, the ECB has clearly stated that the exchange rate is not a policy target, but will carefully monitor the exchange rate. If the Euro will continue to appreciate, central bank intervention cannot be ruled out. We expect some additional ECB action in December.

Does this mean that the Eurozone will remain in a deflationary or low-inflation environment? For the short run, yes, definitely. But for the medium to long-term there are arguments to be made that inflation could return more quickly than after previous recessions, as we have argued in a previous report. This, however, requires more than ‘just’ a combined fiscal and monetary policy, and in the near-term the outlook is clearly not positive.

The months ahead

Now that the Eurozone is in the midst of the second wave and governments have, or are planning to, lockdown economies again, economic recovery is off the table for now. A second economic dip - in the current quarter - is now the most probable scenario – albeit less intense than in Q2. Furthermore we expect the recovery from the second dip to take longer than that of the first dip. As long as there is no vaccine available, governments will have to find a balance between opening up economies and keeping the virus in check. For the foreseeable future we can expect a lot of volatility in GDP figures, but we deem it likely that GDP levels will be lower in the coming quarters than they were in the past quarter. Due to both governments and citizens expected to be more careful to return back to normal. October’s PMIs underscore our expectations. The composite PMI fell for the third month in a row and dropped below the growth neutral level of 50 to 49.4.


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