Growing risk of a second wave - Capital Economics
European Economics

Growing risk of a second wave

European Chart Book
Written by Andrew Kenningham
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The economy is set to rebound strongly in the current quarter after its 12% slump in Q2, even if there is no further increase in GDP in August and September. Indeed, some of the high frequency data suggest that economic activity is almost back to its pre-crisis level already. (See Chart 1.) However, these data can be misleading, and we suspect that overall activity remains between 5% and 10% below its pre-crisis level. Even if there is no further wave of coronavirus, much of the economy will not get back to normal for a long time. And the recent worrying rise in new coronavirus cases in Spain, and more modest increases elsewhere, raises the spectre of a second wave of confinement measures which could easily tip the economy back into recession.

  • The economy is set to rebound strongly in the current quarter after its 12% slump in Q2, even if there is no further increase in GDP in August and September. Indeed, some of the high frequency data suggest that economic activity is almost back to its pre-crisis level already. (See Chart 1.) However, these data can be misleading, and we suspect that overall activity remains between 5% and 10% below its pre-crisis level. Even if there is no further wave of coronavirus, much of the economy will not get back to normal for a long time. And the recent worrying rise in new coronavirus cases in Spain, and more modest increases elsewhere, raises the spectre of a second wave of confinement measures which could easily tip the economy back into recession.
  • Coronavirus indicators show a worrying increase in the number of new cases in Spain.
  • Output indicators suggest that economy is operating around 5-10% below pre-coronavirus levels.
  • Consumer indicators show that retail sales were above their pre-crisis level in June.
  • External indicators suggest that export orders are recovering but only gradually.
  • Labour market indicators show that the number of people on employment support schemes has fallen.
  • Inflation indicators reveal that inflation rose in July, but we think this will be reversed in August.
  • Monetary indicators suggest that bank lending growth has peaked.
  • Fiscal indicators show that government deficits rose sharply in Q1; we expect a bigger increase in Q2
  • Financial indicators suggest that ECB policy support has seen bond yields continue to edge down.

Chart 1: Google Mobility Index (Recreational & Retail)

Source: Google


Coronavirus Indicators

  • The pick-up in euro-zone confirmed cases in recent weeks (2) is largely due to a significant rise in new infections in Spain (3). New infections in Germany and France have been much lower but are also on a gradual upwards trend (4). In Italy, new infections remain stable at a very low level.
  • In Spain, most new infections since the start of July have been in three northeast regions: Catalonia, Aragón and Navarra. Most other regions have had a much smaller increase in infections (5). Compared to April, the latest data show that a greater share of people returning a positive test for the virus are under 40 years old (6). This means that hospitalisations should not rise as quickly as the number of confirmed cases.
  • Meanwhile, the latest survey data show that many people are still concerned about the impact of the virus on their jobs and finances (7). The threat of a second wave in Spain and the euro-zone not only raises concerns for consumers but poses the biggest downside risk to our forecasts and the recovery of euro-zone economies in the next few years.

Chart 2: Euro-zone Confirmed Infections

Chart 3: Spain Confirmed Infections

Chart 4: New Infections (7-Day Average)

Chart 5: Increase in Cases in Spanish Regions (Per Million People, Since 1st July)

Chart 6: Age Breakdown of Positive Tests in Spain (%)

Chart 7: YouGov COVID-19 Tracker
(% of people who are “very” or “fairly worried” that…)

Sources: WHO, Health Ministries, RENAVE, YouGov


Output Indicators

  • Euro-zone GDP slumped by a post-war record of 12.1% q/q in Q2, reducing the economy to the size it was at fifteen years ago (8). The scale of the contraction varied between countries. GDP fell by a comparatively modest 10.1% q/q in Germany but a whopping 18.5% in Spain (9) – a difference that is primarily explained by the duration and strictness of the national lockdowns.
  • Output has recovered in May and June. Vehicle production in May was “only” 25% below its February level in Germany but 60-75% below February levels elsewhere (10). Industrial production rose by 8.2% m/m in Italy in June, though this left it 13% below February levels. And industrial orders shot up by 28% m/m in Germany, led by domestic demand (11), though they also remained well below pre-crisis levels.
  • Business surveys have not been easy to interpret in current circumstances, but they generally point to a further recovery in July. For example, the rebound in the “backlog of work” component of the euro-zone Manufacturing PMI for July (13) suggests that the industrial sector has returned to a more normal state. And the euro-zone Composite PMI point to a continuing recovery in July, though these surveys (12).

Chart 8: Euro-zone GDP (Q1 2007 = 100)

Chart 9: Q2 GDP

Chart 10: Vehicle Production (May cf % of Feb.)

Chart 11: German Industrial Orders (% y/y)

Chart 12: Euro-zone Mfg PMI Backlog of Work

Chart 13: Euro-zone GDP & Composite Output PMI

Sources: Refinitiv, Markit, Capital Economics

Output Indicators (cont.)

  • Some of the high frequency data appear to show that activity has got back to its pre-crisis level. Visits to recreational and retail locations are nearly back to normal in the larger economies, with the notable exception of Spain (14). Restaurant visits are running above pre-crisis levels in Germany and Ireland (15).
  • owever, But other indicators are not so encouraging. Truck mileage in Germany (16) and visits to workplaces (17) are both at subdued levels. Indeed, the number of journeys to work is declining. Meanwhile, people’s reluctance to use public transport (18) reflects a desire to avoid potentially risky enclosed public spaces.
  • In all, GDP was probably running between 5% and 10% below pre-crisis levels during July, with significant variations between countries. We are forecasting a gradual but incomplete recovery from the crisis, with euro-zone GDP remaining a little below its pre-crisis level even at the end of 2022 (19). That is based on an assumption that there is not a major second wave of the virus.

Chart 14: Mobility Index (Retail and Recreational)

Chart 15: In-person Restaurant Diners (7-day Moving Average cf. Pre-Crisis Level)

Chart 16: Germany Daily Truck Toll Mileage Index
(7-day MA, 1st Mar = 100)

Chart 17: Mobility Index (Work)

Chart 18: Public Transport Use (7-day use of Moovit App compared to typical 7-day period pre Jan 15th, %)

Chart 19: Euro-zone GDP (Q4 2019 = 100)

Sources: National Grids, TomTom, Moovit, Google, INSEE, CE


Consumer Indicators

  • Despite the “V” shaped recovery in retail sales (20), we expect euro-zone consumption to recover more gradually and remain below pre-crisis levels for the rest of the year. The 6% increase in retail sales in June left it just above its pre-crisis level. This recovery was boosted by strong online sales and a pick-up in spending on fuel (21). But while sales have returned to pre-crisis levels in most euro-zone economies, they have been slower to recover in Portugal where restrictions have been eased more slowly (22).
  • More timely data show signs that non-retail consumer spending is also rising. Car registrations increased in year-on-year terms in Spain and France in July (23), and high frequency data show that consumers are once more beginning to spend on entertainment such as in cinemas and restaurants.
  • But the recovery in consumer confidence slowed in July (24). Consumers indicated that they are reluctant to spend on major purchases and plan to save more both currently and over the next 12 months (25). As a result, total consumer spending is likely to remain weak for a long time yet.

Chart 20: Euro-zone Retail Sales Volumes
(2015 = 100)

Chart 21: Euro-zone Retail Sales Volumes by Category
(February 2020 = 100)

Chart 22: Euro-zone Retail Sales Volumes by Country
(% change February to June)

Chart 23: New Car Registrations (% y/y)

Chart 24: Euro-zone Consumer Confidence

Chart 25: Euro-zone Consumer Confidence by Category

Sources: Refinitiv, Eurostat, EC, Capital Economics


External Indicators

  • The worst period for exports is probably now behind us, but the recovery is likely to be muted. Exports increased slightly in May compared to April, but they were still nearly 25% below their level a year earlier (26). The collapse in export demand has been broad-based, with sales to both intra- and extra-euro-zone markets having slumped. Not surprisingly, exports to China have held up better than to the US or UK (27).
  • The recovery seems to have continued in June and July. The export orders component of the manufacturing PMI rose to above the 50-mark in July (28) which indicates that exports were still rising. However, the export orders component of the EC’s Economic Sentiment Indictor suggests that this growth will be quite modest in Germany and Italy, and that export orders continued to fall in France (29).
  • We do not yet have a national breakdown for Q2 GDP for many countries. But we know that net exports subtracted 2.3%-points from Q2 GDP in France (30) and 2.8%-points in Spain and that they made a negative contribution to growth in Italy. Finally, the recent re-imposition of travel restriction by some govenrments will hit Mediterranean countries which are most reliant on foreign tourists hard (31).

Chart 26: Exports (€, % y/y)

Chart 27: Exports by Destination (% y/y)

Chart 28: Export Volumes & Mfg PMI Export Orders

Chart 29: EC ESI Export Orders

Chart 30: France GDP (Quarterly ppt Contributions)

Chart 31: Contribution of Foreign Tourists to GDP (%)

Sources: Refinitiv, Markit, Capital Economics


Labour Market Indicators

  • Short-time working will prevent euro-zone unemployment from surging, but the jobless rate will still rise over the next year. In June, it only ticked up from 7.7% to 7.8% (32). But previous months’ data were revised up. One exception is France, where the jobless rate fell again in June (33). This was not due to people dropping out of the labour market (34) so appears to be due to increased hiring.
  • As the worst of the crisis has passed, the number of people on short-time working schemes has declined in France and Spain (35). June data are not yet available for Germany, but timelier data on firms’ applications for the kurzarbeit scheme point to a further fall there too (36). And in Italy, hours authorised for short-time work fell from almost 850m in May to just over 400m in June.
  • Nonetheless, short-time working schemes have been extended in several countries and are likely to continue propping up employment over the next year. But as short-term contracts are not renewed and governments, particularly those with more fiscal constraints, reduce their support for jobs, the euro-zone unemployment rate is still set to rise (37).
  • Chart 32: Euro-zone Unemployment

Chart 33: Unemployment Rate by Country (%)

Chart 34: Number of People Registering at France’s Job Centres After a Period of Inactivity (000s)

Chart 35: Number of Employees on ST Work (millions)

Chart 36: German Workers Covered by ST Working Requests (Millions)

Chart 37: Euro-zone Unemployment Rate (%)

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


Inflation Indicators

  • We expect headline inflation to drop back to around zero in the coming months. Admittedly, the headline rate edged up from 0.3% in June to 0.4% in July as a result of rising core inflation (38). However, this was largely due to a change in the timing of summer sales in several countries including Italy (39) and France (40), which pushed up the core rate. This increase is likely to be reversed in August.
  • The input prices component of the Composite PMI has rebounded as the economy has come out of lockdown (41). Meanwhile, the five-year/five-year inflation swap rate has risen further in the last few weeks (42). But this measure of inflation expectations remains low compared to recent years. And it seems to reflect global factors rather than being a sign that investors fear a sustained surge in euro-zone inflation.
  • Indeed, we still think that inflation is likely to remain well below the ECB’s near-2% target for the foreseeable future (43). And core inflation will probably average little more than 0.5% during the coming years, providing a rationale for the ECB to press on with ultra-loose monetary policy.

Chart 38: Contribs. to Euro-zone HICP (%-pts)

Chart 39: Italy HICP Inflation (% y/y)

Chart 40: Core HICP (% y/y)

Chart 41: Euro-zone Composite PMI (Input Prices)

Chart 42: Five-Year /Five-year Inflation Swap Rate (%)

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

Sources: Refinitiv, EC, ECB, Capital Economics


Monetary Indicators

  • Bank lending growth seems to be past its peak. Adjusted for sales and securitisations it fell from a 10-year high of 5.3% y/y in May to 4.8% in June (44). That was due to a slowdown in lending to firms, which had borrowed heavily during lockdowns to make up for lost revenues, but now are less desperate for bank credit. In month-on-month terms, lending to firms fell to “normal” levels in June (45).
  • Growth in lending to firms in Germany has risen only slightly since the crisis began, perhaps reflecting the country’s lighter-touch lockdown. It has risen much more sharply in France and Spain (46). But as long as there are no new nationwide lockdowns accompanied by new loan guarantees, growth in lending to firms should slow in the second half of the year. Consumer credit growth should remain subdued too (47).
  • Meanwhile, the ECB has slowed its asset purchases recently (48) presumably because improved sentiment towards the euro-zone has reduced the upward pressure on yields. At its current pace, the Bank would hit the €1.35trn PEPP ceiling next June, when it is currently scheduled to end (49). But the lower purchase pace may also be due to the decline in market liquidity over the summer, so we expect bond-buying to pick up again. Eventually we think the Bank will announce another expansion of the PEPP.

Chart 44: Euro-zone Bank Lending (% y/y)

Chart 45: Bank Lending to NFCs (% y/y)

Chart 46: Euro-zone Bank Lending to NFCs (% m/m)

Chart 47: Euro-zone Bank Lending to Households
(% y/y)

Chart 48: ECB Weekly Net Asset Purchases (€bn)

Chart 49: ECB PEPP Holdings (€bn)

Sources: Refinitiv, ECB, Capital Economics


Fiscal Indicators

  • Budget balances will deteriorate significantly this year. The latest region-wide data show that the impact of the pandemic was already evident in Q1, with the euro-zone’s government budget deficit widening from 0.7% of GDP in Q4 to 2.2% of GDP (50). Government spending increased both in absolute terms and as a share of GDP in Q1, while revenue declined but not as much as GDP (51).
  • Since then, governments’ support will push their budget balances much deeper into the red. France’s state budget was in a worse position at the end of June than it was at the same point in 2019, for example (53). We expect euro-zone governments to provide massive discretionary fiscal support this year. Germany is set to spend the most (54), causing its surplus to turn into a huge deficit (55).
  • Meanwhile, the final agreement on the €750bn Recovery Fund late last month marked a major breakthrough but only €390bn (2.8% of EU GDP) will be in the form of grants, less generous than initially proposed. And it will be disbursed over several years. This will not make much difference to debt dynamics, with the southern euro-zone economies shouldering the largest debt burdens next year (56).

Chart 50: Euro-zone Government Budget Balance
(% of GDP)

Chart 51: Euro-zone Government Spending & Revenue (% of GDP)

Chart 52: France State Budget Balance
(Cumulative, % of GDP)

Chart 53: Direct Fiscal Support for 2020
(% of 2019 GDP)

Chart 54: Germany Gen. Gov’t Balance (% of GDP)

Chart 55: Government Debt (2021, % of GDP)

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


Financial Indicators

  • Bond yields in all developed economies have edged down over the past month (56) and we expect continued ECB support to keep sovereign bond yields in the euro-zone very low (57). Corporate bond yields will probably edge down too from already low levels (58), even if the ECB continues to exclude sub-investment grade corporate bonds from its purchase programmes.
  • Meanwhile, equity prices in Europe have fallen over the past month. This might be due to the rise in daily Covid-19 infections, given that equities in Spain have performed particularly poorly. Those in the US have done much better, but that is largely driven by a few tech giants that make up a large share of the US equity market (59). Our forecasts show euro-zone equities reversing their recent losses, but that rests on the assumptions that any second wave of the virus is brought swiftly under control (60).
  • The recent rise in the euro leaves it within touching distance of our end-year forecast (61). Improved sentiment towards the euro-zone, the recovery in risky assets and decline in US real yields have all had a part to play in the euro’s appreciation. We think that there is scope for it to rise a little further by year end.
  • Chart 56: 10-year Government Bond Yields (%)

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

Chart 58: Euro-zone Corporate Bond Yields (%)

Chart 59: Change in Equity Indices (6th July to 4th August)

Chart 60: Equity Prices (1st January 2020 = 100)

Chart 61: US Dollars Per Euro

Sources: Refinitiv, 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
James Yeatman, Research Assistant, james.yeatman@capitaleconomics.com