Deepest downturn since WW2 - Capital Economics
European Economics

Deepest downturn since WW2

European Chart Book
Written by Andrew Kenningham
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The euro-zone is experiencing an unprecedented collapse in economic activity. We suspect that GDP will be roughly 25% below its pre-crisis level during the lockdowns, with the scale of devastation varying between countries. Many sectors of the euro-zone economy have closed completely, and others are operating well below capacity. Activity has fallen furthest in Italy and Spain because the restrictions there have been the most draconian. While the pandemic itself may peak in the coming few weeks, some restrictions are likely to remain in place for months. For now, we still think that the risk of a sovereign debt crisis is low, thanks to the ECB’s scaled-up asset purchase programme. Further ahead, the astronomical cost of the crisis means that governments, businesses and households will all come out of the crisis with significantly impaired balance sheets.

  • The euro-zone is experiencing an unprecedented collapse in economic activity. (See Chart 1.) We suspect that GDP will be roughly 25% below its pre-crisis level during the lockdowns, with the scale of devastation varying between countries. Many sectors of the euro-zone economy have closed completely, and others are operating well below capacity. Activity has fallen furthest in Italy and Spain because the restrictions there have been the most draconian. While the pandemic itself may peak in the coming few weeks, some restrictions are likely to remain in place for months. For now, we still think that the risk of a sovereign debt crisis is low, thanks to the ECB’s scaled-up asset purchase programme. Further ahead, the astronomical cost of the crisis means that governments, businesses and households will all come out of the crisis with significantly impaired balance sheets.
  • Coronavirus indicators show that Covid-19 is still spreading, but new cases have fallen in Italy and Spain.
  • Output indicators point to a massive slump in economic activity throughout the region.
  • Consumer indicators confirm that households have abruptly stopped purchasing many items.
  • External indicators show a slump in new export orders.
  • Labour market indicators point to the unemployment rate soaring in the coming weeks.
  • Inflation indicators show a further sharp drop in headline inflation due to the oil price crash.
  • Monetary indicators reveal that the ECB has already stepped up its asset purchases sharply.
  • Fiscal indicators point to a dramatic rise in national budget deficits.
  • Financial indicators show that the ECB’s extra asset purchases have help to lower bond spreads.

Chart 1: Euro-zone Composite PMI & GDP

Sources: Markit, Refinitiv


Coronavirus Indicators

  • Europe remains the epicentre of the global pandemic with Germany, Italy, Spain and France all among countries with the most confirmed cases in the world. Although there are differences between them, the disease is following a similar trajectory in all four countries (2). At 128,948, the number of confirmed cases in Italy now far exceeds the peak number in Hubei, China (3).
  • There may be some light at the end of the tunnel, however, because the number of recorded new infections has been on a downward trend in Italy since 21st March (4). The lower death rate in Germany may allow it to impose less stringent lockdown measures (5). However, it will still be several weeks before governments begin to ease the restrictions, and when they do so the process may be very gradual.
  • The number of new infections reported per day also seems to be past the peak in Spain and perhaps France and Germany (6). However, the lockdowns look set to be in place for several more weeks. That said, the strictness of government responses has varied between countries (7).

Chart 2: Confirmed Coronavirus Cases (000s)
(Italy at time t, France, Germany & Spain advanced)

Chart 3: Confirmed Coronavirus Cases (000s)
(t= day cases exceeded 200)

Chart 4: Italy Daily New Infections

Chart 5: Deaths (% of Confirmed Coronavirus Cases)

Chart 6: Daily New Infections (000s)

Chart 7: Covid-19 Gov’t Response Stringency Index

Sources: WHO, Health Ministries; Oxford Uni. Bavatnik School of Gov’t


Output Indicators

  • Measures to contain Covid-19 have triggered an unprecedented collapse in activity. The Composite PMI slumped in March and is consistent with output plunging (8) even though many survey responses pre-dated the most severe restrictions. The EC’s Economic Sentiment Indicator painted a slightly less grim picture (9), but probably understates the slump even more as it puts too little weight on services.
  • Private sector output fell sharply in all areas of the economy (10), reflecting the impact of the lockdowns. Services firms’ expectations point to output slumping (11), while the manufacturing output PMI points to a steep fall in industrial production, which was already in recession before the coronavirus (12). Business association data show a 37% y/y drop in German auto production in March.
  • By country, the Composite PMIs have dropped to record lows in all four big euro-zone economies (13). The indices for Spain and Italy were below the German and French ones, which is unsurprising given that the virus hit them earlier, prompting more severe lockdowns.

Chart 8: Euro-zone Composite PMI & GDP

Chart 9: Euro-zone ESI & GDP

Chart 10: Euro-zone PMIs

Chart 11: EZ Services Future Activity PMI &
Services GVA

Chart 12: EZ Manufacturing PMI & Industrial Production

Chart 13: Countries’ Composite PMIs

Sources: Refinitiv, Markit, Eurostat, Capital Economics

Output Indicators (cont.)

  • More timely daily data show that worse is to come if the lockdowns persist throughout April, as seems likely. Electricity consumption in Italy has tanked since the lockdown was imposed and is now down 20% y/y (14). Traffic congestion in Rome and Milan is much less than it was a year ago (15).
  • The decline in traffic congestion has been replicated in other capital cities, with Paris particularly affected (16). The number of new businesses created in France has slowed sharply too over the past month (17), although it is perhaps surprising that they have not fallen even further.
  • Based partly on data that are not publicly available, the French statistics office estimates that activity is now 35% below “normal” levels and that industry and construction, in which remote working is difficult, have suffered big hits (18). Our own forecast is that GDP will drop by 25% during the lockdowns, and that if they last two months annual GDP would fall by nearly 10%, the biggest slump since WW2 (19).

Chart 14: Electricity Consumption in Italy (%y/y)

Chart 15: Traffic Congestion in in Rome and Milan

Chart 16: Traffic Congestion in Other Big EZ Capitals

Chart 17: French Business Creations by Day (7-day ave.)

Chart 18: Insee Estimates of Activity Reduction By Sector

Chart 19: Euro-zone GDP (%y/y)

Sources: Refinitiv, Infogreffe, TomTom, Eurostat, Capital Economics


Consumer Indicators

  • The euro-zone is experiencing an unparalleled slump in household consumption. Demand for numerous goods and services has completely dried up in the past three weeks. There are almost no passenger flights to and from Europe’s major airports (20) and households are unable to spend money on social consumption activities such as going to restaurants or cinemas (21 & 22).
  • Purchases of consumer durables and big-ticket items have also collapsed as people are not permitted to go to shops or showrooms. New car sales in Italy declined by 85% y/y in March (23), where the nationwide lockdown was introduced only on 10th March and non-essential businesses closed on 21st March.
  • Measures of consumer confidence have still fallen sharply, even though they do not capture the full extent of the downturn because they were partly collected before the controls were introduced (24). Spending on restaurants and accommodation and recreation and culture together account for nearly a fifth of the total and will have almost ceased. “Other discretionary” spending will also have been slashed (25).

Chart 20: Flight Departures in Largest Airports in Major Euro-zone Economies

Chart 21: Germany & Ireland Restaurant Bookings

Chart 22: Germany Cinema Ticket Sales (€mn)

Chart 23: Italy New Car Sales (% y/y)

Chart 24: Euro-zone Consumer Confidence & Household Consumption

Chart 25: Consumption by Category (% of Total)

Sources: Refinitiv, FlightRadar24, IMDBPro, MediaMetrie


External Indicators

  • Business surveys point to a sharp fall in exports from the euro-zone in March (26). Orders tanked in the euro-zone’s largest economies and are almost certain to fall below their previous all-time lows which were recorded during the global financial crisis (27 & 28). What’s more, many of the responses to these surveys were collected before the more severe lockdowns were in place.
  • With containment measures being rolled out in key trade partners in March, global economic activity is set to slump, slashing demand for imports from the euro-zone (29). Admittedly, demand from China now seems to be recovering, albeit fitfully. But the US accounts for a much larger share of euro-zone exports, at 15%, and the ISM import orders index suggests demand there has fallen sharply (30).
  • We have estimated elsewhere that world trade volumes could fall by around a fifth during 2020. (See here.) And our forecasts for economic growth in the euro-zone’s key trade partners suggest exports will fall by around 25% y/y in the coming months (31).

Chart 26: Euro-zone Man. PMI Export Orders & Exports

Chart 27: Man PMI New Export Orders By Country

Chart 28: Man PMI New Export Orders By Country

Chart 29: Developed Market Man PMI New Export Orders

Chart 30: US ISM Manufacturing Imports Component

Chart 31: Euro-zone Exports & Trading Partners’ GDP
(% y/y)

Sources: Refinitiv, Markit, Capital Economics


Labour Market Indicators

  • Unemployment in the euro-zone is already shooting up. The latest survey indicators show a sudden drop in firms’ hiring plans, with the PMI employment indicator falling particularly sharply (32). At the national level, the employment PMIs are close to record lows across the region (33).
  • Admittedly, various schemes that allow firms to reduce workers’ hours without making them redundant should protect some jobs. Data from Germany point to a very sharp rise in applications to the “kurzarbeit” programme (34). The picture for France’s “partial unemployment” scheme is very similar (35).
  • But these policies do not cover all firms and all workers, and won’t stop unemployment from soaring. For example, in Spain almost 900,000 workers have already lost their jobs (36). We think that the euro-zone’s unemployment rate will shoot up to about 15% in the coming months, taking it above its previous peak of just over 12% in 2013 (37).

Chart 32: Employment & Firms’ Hiring Expectations

Chart 33: Employment PMIs

Chart 34: German Firms’ Kurzarbeit Applications (000s)

Chart 35: France Partial Unemployment Scheme (000s)

Chart 36: Spain Social Security Registrations (m)

Chart 37: Euro-zone Unemployment Rate (%)

Sources: Refinitiv, National Labour Ministries, Markit, Capital Economics


Inflation Indicators

  • Euro-zone headline inflation fell further in March and is set to turn negative, perhaps as soon as this month. The decline in the headline rate to a five-month low primarily reflected a sharp drop in energy inflation following the plunge in oil prices over the past month (38). The core inflation rate also fell, due to a decline in services inflation. These effects more than offset a rise in food inflation (39).
  • The collapse in oil prices means that energy prices alone are set to be a big drag on headline inflation in the coming months (40). And while the further lengthening of suppliers’ delivery times in March would normally suggest that upward pressure on prices is building (41), in the current climate it simply reflects the depth of the downturn.
  • We expect the disinflationary effect of the shock to demand and rising unemployment to more than offset any supply-driven upward pressure on prices. Indeed, the March business surveys suggest that firms are already reducing their selling prices or expect to do so (42). Overall, we expect the headline rate to drop to close to -1% and the core rate to fall to about zero later this year (43).

Chart 38: Oil Prices & Energy HICP (% m/m)

Chart 39: Contribs. to Euro-zone HICP (%-pts)

Chart 40: Oil Price & Energy Contribution to Inflation

Chart 41: Suppliers’ Delivery Times & Manufacturing Input Prices PMIs

Chart 42: Surveys of Firms’ Selling Prices

Chart 43: Euro-zone HICP (% y/y)

Sources: Refinitiv, Markit, Capital Economics


Monetary Indicators

  • The ECB has significantly improved funding conditions for banks. It has increased lending in US dollars to above the levels seen during the eurozone debt crisis (44), and lending under its more generous Longer-term Refinancing Operations (LTROs) has increased by 34% over the past two weeks, to €825bn (45).
  • Admittedly, uptake of the Bank’s Targeted LTROs was still quite low in March (46). But banks had little time to adjust to the new TLTRO terms before March’s operation took place, so demand in June will probably be much stronger. After the ECB raised the limit for TLTRO borrowing from 30% of eligible loans to 50%, there is plenty of scope for it to rise (47).
  • At the same time, the Bank significantly stepped up its bond purchases in the last two weeks of March. Chart (48) shows central bank purchases under its Asset Purchase Programme, while the Bank also bought €15.6bn of bonds on the first two days of the Pandemic Emergency Purchase Programme, which opened on 26th March. All of this has taken the Bank’s balance sheet above €5trn for the first time (49).

Chart 44: Eurosystem Claims on Euro-zone Residents
in Foreign Currency (€bn)

Chart 45: Longer-term Refinancing Operations (€trn)

Chart 46: TLTRO Uptake (€bn)

Chart 47: Longer-term Refinancing Operations by Country (as % of Eligible Loans)

Chart 48: Weekly Change in ECB APP Holdings (€bn)

Chart 49: ECB Balance Sheet (€trn)

Sources: Refinitiv, ECB, Capital Economics


Fiscal Indicators

  • Governments have announced large aid packages to help fight the impact of the coronavirus in the form of supplementary budgets and loan guarantees, as well as delayed or deferred tax payments. These will increase government deficits and debt ratios (50). Germany’s response will push its budget surplus into a deficit of at least 4% of GDP this year – even bigger than during the global financial crisis (51).
  • Automatic stabilisers will also push budget deficits higher – when GDP falls tax revenues also decline and budget deficits increase even if governments don’t boost spending. This effect tends to be relatively large in Europe due its comparatively generous welfare systems (52). All told, we think that deficits will deteriorate by 20% of GDP this year and nominal GDP will fall by 10% or so, pushing up debt ratios (53).
  • Meanwhile, finance ministers are yet to agree a way to exploit the European Stability Mechanism’s (ESM) lending capacity to offer financial help to all member states. Original suggestions show that any help will be minimal though at around 2% of GDP (54). The ESM rules suggest the cost of these credit lines won’t be attractive for everyone either (55).

Chart 50: Increase in Gov’t Deficit and Debt from Measures Already Announced (2020, % of GDP)

Chart 51: Germany General Government Balance
(% of GDP)

Chart 52: Effect on Budget Deficit (As a % of GDP) of Each 1 Percentage Point Rise in the Output Gap

Chart 53: Government Debt (2020, % of GDP)

Chart 54: Potential ESM Support (2% of GDP, €bn)

Chart 55: ESM & Italian Gov’t 10-year Bond Yield (%)

Sources: Refinitiv, National Finance Ministries, Eurostat, CE, EC


Financial Indicators

  • Euro-zone bond yields went on a rollercoaster ride in March (56), but with the ECB now buying potentially huge volumes of government bonds, we think that yields outside Germany will fall and spreads will narrow over the rest of the year (57). Corporate bond yields will probably decline too (58).
  • Based on the assumption that the global spread of the virus slows during the summer, safe-haven demand will probably decline, so Bund yields might edge up while risky assets outperform. Accordingly, we think that equity prices will rise, though they are unlikely to recover all of their losses from Q1 (59). And narrower bond spreads would probably cause peripheral banks’ equity prices to outperform (60).
  • Meanwhile, the euro strengthened in early March as US interest rates expectations fell, but the currency then weakened as the demand for dollars increased. We suspect that the euro will end this year around its current level against the dollar (61).
  • Chart 56: 10-year Government Bond Yields (%)

Chart 57: 10-year Government Bond Yields (%)

Chart 58: Corporate Bond Yield (%)

Chart 59: Germany & US Equity Indices
(1st January 2020 = 100)

Chart 60: Italian Bank Equity Prices & Bond Spreads

Chart 61: US Dollars per Euro

Sources: Refinitiv, Bloomberg, Capital Economics


Andrew Kenningham, Chief Europe Economist, andrew.kenningham@capitaleconomics.com
Jack Allen-Reynolds, Senior Europe Economist, jack.allen-reynolds@capitaleconomics.com
Jessica Hinds, Europe Economist, jessica.hinds@capitaleconomics.com
Melanie Debono, Europe Economist, melanie.debono@capitaleconomics.com