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Eurozone: K-shape recovery

Economic Quarterly Report

  • The GDP contraction in the eurozone has been historically sharp, but the economic rebound will likely be robust in Q3
  • After Q3, we expect the recovery to stall until a COVID-19 vaccine is available
  • We forecast that eurozone GDP will contract by 8.9% in 2020, followed by growth of 4.3% in 2021
  • Some countries weathered the storm better than others—in Germany, for example, the trough was less deep
  • The crisis has widened the gap between different sectors and socio-economic classes 

Rebound follows historical contraction in GDP

The GDP figures for the second quarter painted a historically bleak picture. The eurozone economy contracted by 11.8% (figure 1), which is an unprecedented collapse in peacetime. But now that economies have opened up again, we expect the figures for the third quarter to be good in historical terms. Nonetheless, it would be naïve to expect GDP to return to pre-COVID levels by the end of this quarter.

The economic data that have been released so far do indeed indicate a strong recovery in the third quarter, but more recent sentiment figures suggest that the pace of economic recovery will slow. PMI figures are still slightly positive (above 50), but have failed to improve further.

Figure 1: GDP Contractions in Q2 Have Been Historically Sharp
Figure 1: GDP Contractions in Q2 Have Been Historically SharpSource: Eurostat, National Statistical Offices
Figure 2: Composite PMI Figures Indicate the Stalling of Economic Recovery
Figure 2: Composite PMI Figures Indicate the Stalling of Economic RecoveryNote: If the index rises above 50, economic activity should improve compared to the previous month.
Source: Macrobond, Markit.

Going Forward, Uncertainty Reigns

The future of Europe remains clouded in uncertainty, both from an economic and a health perspective. The recent surge of new infections, especially among young people, has not yet led to a significant rise in hospitalizations, but governments are keeping a close eye on developments.

Although we do not expect governments to impose another round of nation-wide lockdowns, they could adopt a more targeted approach. For example, governments could shut down specific regions or sectors that have proven to be a virus hotbed. In any case, in the short run, it is more likely that the restrictions will be tightened rather than loosened.

We have adjusted our forecast accordingly. In line with the recently released economic figures and sentiment data, we expect economic activity to be constrained until a vaccine becomes widely available in Europe. We forecast GDP to pick up again after a vaccine is widely available, and to gradually return to (close-to) pre-COVID levels. Our baseline assumes that a large share of eurozone inhabitants will have been vaccinated in the second quarter of 2021. However, the pace of that re-adjustment to ‘normal’ is likely to differ considerably between sectors, whilst the ‘normal’ itself is likely to have changed (and shift down) as well.

Until a vaccine is available, some companies and employees are dependent on life-lines from the government. So far, these relief packages have prevented a surge bankruptcies and the unemployment rate. But even though the current job retention programs will prevent a spike in unemployment for now, sooner or later, governments will have to gradually wind down their economic support. When that happens, bankruptcies and unemployment will inevitably rise.

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

The K-shape Recovery

In April economists were arguing about the shape of the economic recovery. Optimists were routing for a V-shape recovery, while others expected an L-shape, or even a U-shaped recovery. But the debate has now shifted to another letter of the alphabet. A K-shape recovery indicates that the economic recovery of countries and/or sectors diverges. We have argued before that further divergence is looming for euro area member states. But the crisis has also driven a wedge between sectors and socio economic classes.

Differences in the Labor Market

In order to preserve jobs during the pandemic, governments created job retention programs. So far, these programs have prevented large spikes in unemployment, but could not completely prevent layoffs. With poor prospects of finding a job, many people have simply left the labor force (figure 3). Should these people return as job-seekers during the recovery phase, this is likely to push up unemployment rates. Moreover, the bulk of people who lost their job during the pandemic are typically young people working low-wage jobs on temporary contracts (figure 4). They generally have few reserves to fall back on. Given this and the fact that the central bank liquidity is continuing to inflate prices of assets generally held more by older and wealthier people, the gap between socio-economic classes is widening.

Figure 3: The Labor Force Has Contracted Sharply in Q2 for Some Countries
Figure 3: The Labor Force Has Contracted Sharply in Q2 for Some CountriesSource: National Statistics Agencies
Figure 4: Temporary Contracts Have Been More Vulnerable Than Permanent Contracts in Italy
Figure 4: Temporary Contracts Have Been More Vulnerable Than Permanent Contracts in ItalySource: Macrobond, Istat

Differences Between Sectors

The impact of the crisis has not been equally distributed between sectors either. Some sectors, such as the aviation and the tourism sector, were more vulnerable to the effects of lockdown. These sectors have not been able to recoup their losses during the recovery phase like other sectors could, for example, e-commerce. Moreover, they may also be the last to return to ‘normal’.

Figure 5: Economic Expectations Indicate Diverging Sector Fortunes in Germany
Figure 5: Economic Expectations Indicate Diverging Sector Fortunes in GermanySource: Macrobond, DGECFIN
Figure 6: Exports of Eurozone Countries vs. World Trade
Figure 6: Exports of Eurozone Countries vs. World TradeSource: Macrobond, CBS, National Statistical Offices

Another hard-hit sectors include those that are export-oriented like manufacturing. COVID-19 has hampered global supply chains through factory and border closures and thus especially affected world trade. European countries that imposed strict lockdowns were relatively vulnerable (figure 6). Now that the borders within the Schengen area are open again, trade has picked up. But trade is not out of the doldrums yet. Most companies still have a significantly smaller export order books and the pickup has been marginal. With the probability of a second wave of infections still high, the recovery in exports remains subdued. The recovery in foreign trade is much weaker than in domestic trade.

Differences Between Countries

As we argued in a previous piece, economic damage and recovery depend on the severity of the lockdown, the structure of the economy, and the ability of the government to mitigate economic damage through fiscal stimuli.

Although Germany is more dependent on international trade than other eurozone member states, it has fared considerably better, in part thanks to its generous government support. The economic trough was not as deep as in Germany it was in other countries (figures 7 & 8). For comparison, the damage to the Spanish economy was twice that of the damage to the German economy. (22% y/y contraction vs. 11% y/y contraction for H1 2020). The prospects going forward are considerably better for Germany as well. Other countries, such as Italy, Spain and France, which are more dependent on tourism and the leisure sector for example, will have to undergo more drastic changes to adjust to the new economy.

Figure 7: Retail Sales Including Vehicles
Figure 7: Retail Sales Including VehiclesSource: Macrobond, National Statistical Offices
Figure 8: Expectation for New Industry Orders
Figure 8: Expectation for New Industry OrdersSource: Macrobond, DG ECFIN

The EU tries to halt this divergence by means of the recovery fund. In the short term, agreement on the fund by the EU is already supporting especially Southern member states as it has narrowed peripheral spreads , enabling those countries to attract funding on the capital markets for a friendlier price. In the longer run, when the additional money actually starts to flow, the fund supports the economies  via more structural investments and economic reform.  According to the European Commission, extra investments could lead to a 1.5 to 2.25 percentage points higher Eurozone GDP level by 2024, depending on the take up of the loan component. Additional factors are crowding out effects and the timing of the investments. For weaker member states with high debt and below average GDP per capita, such as Italy and Spain, the estimated impact is larger.  But the impact of economic reforms, which are required in return for the financial support, could be even larger. The OECD estimated that economic growth could rise by 1 percent point per year if Italy would properly implement them. And with close to EUR 200bn (over 10% of GDP) in grants and loans from the fund (according to sources), Italy seems to have quite some incentive to make it work. Admittedly, economic reforms are often met with resistance and not every country has proved to be able to reform. Yet the fact that Italy has recently proved willing to take some steps is promising . What these reforms will be remains to be seen. France is the only country to propose plans for economic reforms financed by the recovery fund so far.


The crisis has left craters in the eurozone economy. And now that the dust has started to settle, we can see that the impact was not equally distributed. Not over countries, not over sectors and not by socio-economic status. Governments are trying to halt this divergence through active support to companies and employees. And so far, this has prevented a sharp rise in unemployment and bankruptcies. But this support cannot be a solution for the long-term. The structure of the economy will change and people might have to find work in another sector than the sector they’re currently working in.

Erik-Jan van Harn
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 3002 0936

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