Lessons for 2021 - Capital Economics
European Economics

Lessons for 2021

European Economics Weekly
Written by Jessica Hinds

Based on this year’s experience, activity should rebound quickly in 2021 once restrictions are lifted, probably during Q2. But with price pressures set to remain very weak at least for the next couple of years, the ECB will continue to keep financing conditions very loose, even as the recovery gets underway.

With this being our final Weekly of 2020, it seems like a good opportunity to cast an eye back over this year, and draw some lessons for next year too.

Lesson 1: acknowledge the uncertainty

We aren’t going to be too harsh on ourselves for not seeing the pandemic coming… and hopefully you won’t be either. With any luck, we won’t have a similar-sized curveball thrown at us in 2021. But the degree of uncertainty about the future is still very high. In these unusual circumstances, the best we can do is to make educated judgements about how quickly vaccines will be rolled out and how quickly the restrictions on activity will be lifted.

Lesson 2: economic rebound could be strong

While the latest surveys published this week suggest the euro-zone economy ended 2020 on a slightly stronger note than we had anticipated, GDP will still contract in Q4. And with tougher measures now in place in Germany and the Netherlands, the euro-zone will start next year on the back foot. But the good news is that this year’s experience shows that the economy can rebound quickly when lockdowns are lifted. (See Chart 1.) And if restrictions on tourism are removed by the summer, that rebound has the potential be even stronger.

Chart 1: CE Mobility Tracker vs. Weighted Avg. of Industrial Prod, Retail Sales & Construction

Sources: Google, Refinitiv, Capital Economics

Lesson 3: labour market will be resilient

One reason for the strength of this rebound will be the initially surprising resilience of the labour market. Short-time working schemes throughout the region have kept a lid on unemployment this year even as economic activity collapsed. These policies have largely been extended well into 2021 and in most cases remain exceptionally generous. Jobs will still be lost, but the risks of a surge in unemployment next year now seem fairly small.

Lesson 4: the pandemic has been disinflationary

When the pandemic began, it was not clear whether it would be inflationary or deflationary. But we were right to argue that inflation would fall, and the core rate is now barely above zero. There are few signs of price pressures even when digging into the detail of the inflation data. (See here.)

As the economy gets back towards normality, prices that have fallen most sharply this year – flights, holidays, clothes – may experience bigger increases. So there could be a marked pick-up in core inflation, perhaps to above 1%. But this would be driven by base effects, so it would only be temporary. It should not be seen as a sign that policymakers have finally let the inflation genie out of the bottle. Only a more widespread acceleration in inflation would cause us to re-think our view that price pressures will remain very weak at least for the next couple of years.

Lesson 5: policymakers will pull out all the stops

This year European policymakers have stepped up to the plate and, on the whole, delivered. We expect that willingness to provide monetary policy support to be sustained next year. The ECB has already stressed that it will keep conditions very loose, even as the recovery gets underway. The outlook for fiscal policy is more varied between countries, but there is little risk of a repeat of the austerity which contributed to the euro-zone crisis.

The weeks ahead

There are no major data releases scheduled for the rest of this year. The usual month-end rush of data, including the Economic Sentiment Indicator and euro-zone inflation for December will be published in the first week of 2021. In the meantime, the Brexit deadline of 31st December is looming.


Data Previews

Euro-zone Composite PMIs (Dec.) Wed. 6th Jan.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Spain

08.15

41.7

48.5

Italy

08.45

42.7

45.0

Partial easing of restrictions to boost Italy’s PMI

The Spanish and Italian Composite PMIs probably rose in December, but economic activity will still have been weak, particularly in the services sector.

The flash estimates for the euro-zone, Germany and France were published before Germany entered a tough lockdown on 16th December, and it is possible these estimates are revised down in the final release.

The Markit press release for the flash estimate noted that outside of France and Germany, the PMI for the rest of the euro-zone rose to 47.5 in December. This implies fairly big increases in Italy and Spain. Admittedly, our Mobility Tracker for Italy, which has previously been a reliable guide to the Composite PMI, edged down. But as restrictions were eased at the end of November, a rise in the index seems likely. (See Chart 2.) Meanwhile, Spain’s Composite PMI probably edged up a bit too, albeit by less since there has been little change to either restrictions or mobility there.

The big picture is that economic activity in both countries is likely to have remained weak in December, and we expect this to be sustained in the early part of next year.

Chart 2: Italy Mobility Tracker & Composite PMI

Sources: Google, Markit, Capital Economics

Euro-zone Flash HICP (Dec.) Thu. 7th Jan.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

HICP m/m (y/y)

10.00

-0.3% (-0.3%)

(-0.3%)

+0.2% (-0.3%)

Core HICP m/m (y/y)

10.00

-0.5% (+0.2%)

+0.4% (+0.2%)

Core inflation remains close to zero

We think that inflation was unchanged in December relative to November.

Recall that headline inflation held steady in November at -0.3%, while the core rate was also unchanged, at just +0.2%.

We suspect that the core rate remained steady again in December. Meanwhile, the fall in oil prices so far this month points to energy inflation edging further into negative territory, but food inflation is likely to have held up. On balance, we have pencilled in no change in the headline rate too.

Looking ahead, we expect underlying inflation to remain very low even after the lockdowns have ended. The current weakness of core inflation is due to more than just tourism. (See Chart 3.)

Headline inflation should rise a bit by next summer as the drag from the previous falls in oil prices drops out of the annual comparison. But the big picture is that price pressures will remain very subdued, and well below the ECB’s target.

Chart 3: Euro-zone Core Inflation (%)

Source: Refinitiv, Capital Economics

Euro-zone EC Cons. Conf. & EC ESI (Dec.) Mon. 21st Dec./Thu. 7th Jan.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

21st December

Euro-zone Consumer Confidence

15.00

-17.6

-19.0

-19.0

7th January

Euro-zone ESI

10.00

87.6

87.4

90.0

Improvement, but activity still weak

We think that the European Commission’s Economic Sentiment Indicator (ESI) rose in December, but will have remained below its long-run average.

Given the tightening of virus restrictions, it was no surprise that the ESI fell in November, from 91.7 in October to 87.6. We have little to go on, but we think the index edged up in December.

Admittedly, consumer confidence, which accounts for 20% of the index, is likely to have deteriorated as tighter restrictions in Germany and the Netherlands more than offset increased optimism about a vaccine. In contrast, business sentiment is likely to have risen, echoing the message from the Composite PMI as well as business climate surveys in France and Germany. We have pencilled in a rise to 90.0 for the euro-zone ESI.

At face value, this would be consistent with GDP remaining negative in y/y terms in Q4. (See Chart 4.) Looking ahead, with restrictions set to persist in the early part of next year, we expect the ESI to remain low in the coming months.

Chart 4: Euro-zone ESI & GDP

Sources: Refinitiv, Capital Economics

Germany Industrial Production (Nov.) Thu. 7th Jan.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Industrial Production m/m (y/y)

07.00

+3.2%(-2.7%)

+0.3%(-2.1%)

+2.5%(-1.2%)

Another increase

We think that industrial output in Germany probably increased again in November and the sector is likely to hold up reasonably well despite the lockdown.

Industrial production rose by 3.2% m/m in October, which left it around 5% below its pre-virus level.

Another rise in November looks likely. Business surveys suggest that the sector continued to grow. Indeed, while the manufacturing output PMI fell that month, it was still well above the 50 “no change” level. Continued fast growth in Asia, with which Germany has close ties, and the fact that the lockdown measures are focused on services, suggests that industry recorded another strong month. All in all, we are pencilling in a 2.5% m/m increase in industrial production versus October. That would leave output around 2.5% below its level in February, which would still be a bigger shortfall than in the other major euro-zone economies.

The industrial sector is likely to continue to fare well. Admittedly, Germany’s new tougher lockdown is likely to remain in place into January. But the restrictions are not aimed directly at industry and high frequency data such as daily truck toll mileage data point to a further improvement. (See Chart 5.)

Chart 5: Truck Toll Mileage & Ind. Prod.

Sources: Refinitiv, DESTATIS


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time CET

Time (GMT)

Previous*

Median*

CE Forecasts*

Mon 21st

Ger

GfK Consumer Confidence (Jan)

08.00

(07.00)

-6.7

-7.5

EZ

Consumer Confidence (Dec, Flash)

16.00

(15.00)

-17.6

-19.0

-19.0

Tue 22nd

No Significant Data Released

Wed 23rd

Bel

CPI (Dec, EU Harm)

0.0%(+0.4%)

Spa

GDP (Q3, Final, q/q(y/y))

09.00

(08.00)

+16.7%(-8.7%)p

+16.7%(-8.7%)

+16.7%(-8.7%)

Ita

Consumer Confidence (Dec)

10.00

(09.00)

98.1

97.5

Thu 24th

Net

GDP (Q3, Final, q/q(y/y))

06.30

(05.30)

+7.7%(-2.5%)p

+7.7%(-2.5%)

Fri 25th – Sun 3rd

CE

London Office is closed

Selected future data releases and events

Mon 28th

Spa

Retail Sales (Nov)

09.00

(08.00)

+0.6%(-2.7%)

Tue 29th

No Significant Data Released

Wed 30th

Spa

CPI (Dec, EU Harm., Prov.)

09.00

(08.00)

+0.1%(-0.8%)

(-0.6%)

Mon 4th

EZ

Markit Manufacturing PMI (Dec, Final)

10.00

(09.00)

55.5p

55.5

Por

CPI (Dec, EU Harm., Prov.)

10.30

(09.30)

-0.5%(-0.4%)

Tue 5th

Ger

Retail Sales (Nov)

+2.6%(+8.6%)

-2.0%(+2.3%)

EZ

M3 Money Supply (Nov)

10.00

(09.00

(+10.5%)

Ger

Unemployment Rate (Dec)

09.55

(08.55)

6.1%

6.2%

Wed 6th

Fra

CPI (Dec, EU Harm., Prov.)

08.45

(07.45)

+0.2%(+0.2%)

EZ

Markit Composite PMI (Dec, Final)

10.00

(09.00)

49.8p

49.8

EZ

Markit Services PMI (Dec, Final)

10.00

(09.00)

47.3p

47.3

Ger

CPI (Dec, EU Harm, Final)

14.00

(13.00)

-1.0%(-0.7%)p

+0.6%(-0.6%)

Thu 7th

EZ

ECB Economic Bulletin

10.00

(09.00)

EZ

Retail Sales (Nov)

11.00

(10.00)

+1.5%(+4.3%)

-3.0%

EZ

EC Business & Consumer Survey (Dec)

11.00

(10.00)

87.6

87.4

90.0

EZ

Flash CPI (Dec)

11.00

(10.00)

(-0.3%)

(-0.3%)

(-0.3%)

Fri 8th

Ger

Industrial Production (Nov)

08.00

(07.00)

+3.2%(-3.0%)

+0.3%(-2.1%)

+2.5%(-1.2%)

EZ

Unemployment Rate (Nov)

11.00

(10.00)

8.4%

8.5%

*m/m(y/y) unless otherwise stated. p=provisional. Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q(%y/y) unless stated

Latest

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

2019

2020

2021

2022

GDP

+12.5(-4.3)

-3.0(-7.3)

+0.8(-2.9)

+2.9(+13.2)

+2.7(+3.3)

+0.8(+7.3)

+1.3

-7.5

+5.0

+4.0

Household Spending

+14.0(-4.6)

-4.0(-8.5)

+1.6(-2.6)

+3.5(+15.0)

+2.2(+3.2)

+0.7(+8.2)

+1.3

-8.2

+5.6

+3.6

HICP (%y/y)

-0.3 (Nov)

-0.2

-0.1

+0.6

+0.7

+1.0

+1.2

+0.3

+0.5

+0.8

Unemployment Rate (%)

8.4 (Oct)

8.5

9.3

9.1

8.9

8.6

7.6

7.8

9.0

8.0

Depo Rate, end period (%)

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

10yr Bund Yield, end period (%)

-0.56

-0.50

-0.50

-0.50

-0.50

-0.50

-0.19

-0.50

-0.50

-0.50

$/euro, end period

1.23

1.20

1.21

1.23

1.24

1.25

1.12

1.20

1.25

1.30

£/euro, end period

0.91

0.89

0.89

0.89

0.89

0.89

0.85

0.89

0.89

0.90

Sources: Bloomberg, Capital Economics


Jessica Hinds, Europe Economist, jessica.hinds@capitaleconomics.com