Q4 contraction before fairly quick rebound in 2021 - Capital Economics
European Economics

Q4 contraction before fairly quick rebound in 2021

European Economics Weekly
Written by Jack Allen-Reynolds
Following the flurry of positive news on vaccines, we have revised up our economic forecasts for 2021 and 2022. Among the major economies, we think that Germany will be the standout performer. Spain should rebound quickly next year, but will take longer to regain is pre-coronavirus level of activity. We will discuss our new forecasts in more detail in a webinar next week.

Webinar Invite: The European outlook – From lockdowns to vaccines

Thursday, 3 December

Chief Europe Economist Andrew Kenningham will lead this special briefing with colleagues Jessica Hinds, Jack Allen-Reynolds and David Oxley to discuss Europe’s economy under lockdown. The team will preview the ECB’s December meeting, assess Sweden’s attempts to control the pandemic, and look ahead to the potential economic impact of vaccines in 2021. Complimentary registration here.

Mounting evidence of Q4 contraction

Data published this week for November added to the evidence that the euro-zone economy will experience a sharp contraction in Q4, at least by pre-pandemic standards. The Economic Sentiment Indicator declined, and the less forward-looking Composite PMI fell to its lowest level since May. (See here and here.) We forecast the euro-zone economy to shrink by 3% q/q in Q4.

The surveys for Germany have held up fairly well. We have pencilled in a decline in German GDP of just 0.5% q/q, and it might avoid a contraction altogether. However, we expect declines of closer to 3% in Italy, 4% in France and 5% in Spain.

Updating our forecasts

Nevertheless, following the flurry of positive news on vaccines, we have revised up our economic forecasts for 2021 and 2022. It now looks as if the most vulnerable members of the population – particularly the elderly – will be vaccinated by around April next year (see here), which would allow governments to begin removing their containment measures. Crucially, we don’t think that authorities will wait until the population as a whole has got close to herd immunity before re-opening the economy.

We have pencilled in euro-zone GDP to reach its pre-crisis level in the first quarter of 2022. At the national level, we expect Germany to outperform and Spain to lag behind. (See Chart 1.)

Chart 1: GDP (Q4 2019 =100)

Sources: Refinitiv, Capital Economics

These differences at the national level are driven by three key factors. The first is that countries which were hit harder by the pandemic and lockdowns will take longer to get back to normal. For example, the more workers who lost their jobs, the longer it will take for employment to recover. And in countries where household and corporate incomes fell further, private sector balance sheets will be in worse shape.

The second factor is the structure of the economy. Germany’s large export sector puts it in a good position to benefit from rapid growth in other regions, particularly emerging Asia. By contrast, although Spain’s tourist sector should recover quickly from its current state, the overall economy may not get back to full capacity for a while yet, not least because of the depth of the downturn this year.

The third factor is the degree of policy support this year and the pace at which it is scaled back. Governments with lower levels of debt and lower bond yields are in a better position to maintain fiscal support, whereas Spain’s government has seemed more intent on bringing its budget deficit down fairly quickly. The European Commission has encouraged the governments of France and Italy to “preserve” fiscal sustainability, which is a potentially worrying sign that euro-zone policymakers haven’t completely lost their fiscally conservative instincts.

The week ahead

The highlight of next week will of course be our webinar, “The European outlook – from lockdowns to vaccines”, at 3pm on Thursday 3rd December. We will cover a range of topics including the impact of vaccines on euro-zone economies, the outlook for ECB policy, and lessons from Sweden’s laissez faire approach to the virus.

Meanwhile, we expect data to show that euro-zone retail sales rose in October, while core inflation remained close to zero in November. We also suspect that Italy’s PMI will have fallen below Spain’s in November.


Data Previews

Euro-zone Flash HICP (Nov.) Tue. 1st Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

HICP m/m (y/y)

10.00

+0.2% (-0.3%)

-0.3%(-0.2%)

-0.2%(-0.1%)

Core HICP m/m (y/y)

10.00

+0.1% (+0.2%)

(+0.2%)

-0.5%(+0.2%)

Core inflation remains close to zero

Rising food prices are likely to have nudged the headline inflation rate up, but the core rate looks set to have been unchanged at barely above zero.

Core inflation fell during the first lockdown, from 1.2% in February to 0.9% in April, largely due to declines in clothing and holiday prices. But the current lockdowns are not as strict, and the November data for France show that while goods inflation fell, services inflation rose. We suspect the euro-zone core rate was steady at around 0.2%.

The French data also show that food inflation picked up, just as it did during the first lockdown. Despite the rise in oil prices this month, year-on-year energy inflation is likely to be little changed.

More generally, the weakness of core inflation since the beginning of the year is due to more than just clothes and tourism. (See Chart 2.) We expect underlying inflation to remain low even after lockdowns end, as weak demand keeps price pressures subdued.

Chart 2: Euro-zone Core Inflation (%)

Source: Refinitiv, Capital Economics


Germany & EZ Unemployment Rate (Nov./Oct.) Tue. 1st Dec/Wed. 2nd Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Tuesday 1st December

Germany Unemp. Rate (Nov.)

08.55

6.2%

6.3%

6.2%

Wednesday 2nd December

Euro-zone Unemp. Rate (Oct.)

10.00

8.3%

8.4%

8.4%

Edging up

We think that the German unemployment rate was probably unchanged in November while the euro-zone rate edged up in October.

The German unemployment rate has fallen from a peak of 6.4% in June to 6.2% in October. Business surveys such as EC Employment Expectations Indicator rose only a touch in November and suggest that employment growth remained weak.

Meanwhile, surveys for the euro-zone suggest that employment growth is still falling in y/y terms across the region as a whole. (See Chart 3.) We think that the jobless rate rose in October. Looking ahead, the risk of a sudden surge in unemployment has diminished as most governments have extended their short-time working schemes. And with the prospect of a vaccine next year, the demand for labour should revive. We still expect the unemployment rate to rise further in the coming six months or so, to peak at about 9% before gradually coming down again.

Chart 3: PMI Employment & Employment

Sources: Markit, Refinitiv, Capital Economics

Composite PMIs (Nov.) Thu. 3rd Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Spain

08.15

44.1

43.5

Italy

08.45

49.2

41.5

Restrictions take toll on Italian activity

The Spanish and Italian Composite PMIs probably dropped again in November, with the tighter restrictions in Italy pointing to a bigger fall there.

We expect no change to the initial estimates for the PMIs for the euro-zone, France, Germany, all three of which fell because of weaker Services PMIs.

The Markit press release for the flash PMI noted that outside of France and Germany business activity fell at its fastest pace since May 2009 other than at the height of the pandemic, with the Composite PMI for the rest of the euro-zone falling to just 42.4.

Restrictions imposed in Italy earlier this month have caused our Mobility Tracker to fall sharply. This points to a big fall in Italy’s Composite PMI. (See Chart 4.) Since restrictions are now more severe in Italy than in Spain, we suspect Spain’s index will be slightly higher, at 43.5 compared to Italy’s 41.5.

The big picture is that economic activity is likely to have slowed in both countries in November, but at a much slower rate than during the spring lockdowns.

Chart 4: Italy Mobility Tracker & Composite PMI

Sources: Google, Markit, Capital Economics

Euro-zone Retail Sales (Oct.) Thu. 3rd Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Euro-zone Retail Sales m/m (y/y)

10.00

-2.0% (+2.2%)

+0.5%(+2.6%)

Small rise but worse to come

Retail sales are likely to have risen a touch in October but this probably reversed in in November, as restrictions were tightened substantially.

In September, retail sales fell by 2% m/m, so that volumes were only about 1% above February’s level. For October, the national data suggest sales might have recovered a little. They show a fall in Ireland, but small rises in Spain and Finland and a jump in France. But the Bank of France measure of retail sales is typically more volatile than the official data, so we suspect the rise wasn’t quite as big. Overall, we think that euro-zone retail sales might have risen by about 0.5% m/m in October, leaving them 1.6% above their pre-pandemic level. (See Chart 5.)

Given that governments have ramped up restrictions, and non-essential shops shut in parts of the region, a further fall is all but assured in November. Moreover, other types of consumption, such as “social spending” in restaurants, will have been hit even harder, meaning that overall household spending is set for a terrible quarter.

Chart 5: Euro-zone Retail Sales (January 2020 = 100)

Sources: Refinitiv, Capital Economics


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time CET

Time (GMT)

Previous*

Median*

CE Forecasts*

Mon 30th

Spa

CPI (Nov, Prov, EU Harm.)

09.00

(08.00)

+0.3%(-0.9%)

Ita

CPI (Nov, Prov., EU Harm.)

11.00

(10.00)

+0.6%(-0.6%)

EZ

ECB’s Lagarde speaks at EPC Forum

11.30

(10.30)

Ger

CPI (Nov, Prov., EU Harm.)

14.00

(13.00)

+0.0%(-0.5%)

-0.6%(-0.1%)

Tue 1st

Spa

Markit Manufacturing PMI (Nov)

09.15

(08.15)

52.5

50.0

Ita

Markit Manufacturing PMI (Nov)

09.45

(08.45)

53.8

52.0

Ger

Unemployment Rate (Nov, s.a)

09.55

(08.55)

6.2%

6.3%

6.3%

EZ

Markit Manufacturing PMI (Nov, Final)

10.00

(09.00)

53.6p

53.6

53.6

Ita

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

10.00

(09.00)

+16.1%(-4.7%)p

+16.1%

16.1%(-4.7%)

EZ

Flash HICP (Nov)

11.00

(10.00)

+0.2%(-0.3%)

-0.3%(-0.2%)

-0.2%(-0.1%)

EZ

Flash Core HICP (Nov)

11.00

(10.00)

+0.1%(+0.2%)

(+0.2%)

(+0.2%)

Wed 2nd

Ger

Retail Sales (Oct)

-1.9%(+7.0%)

+0.9%(+5.2%)

Ita

Unemployment Rate (Oct, Prov.)

10.00

(09.00)

9.6%

EZ

Unemployment Rate (Oct)

11.00

(10.00)

8.3%

8.4%

8.4%

EZ

ECB’s Philip Lane speaks at fireside chat

15.00

(14.00)

Thu 3rd

Spa

Markit Composite PMI (Nov)

09.15

(08.15)

44.1

43.5

Ita

Markit Composite PMI (Nov)

09.45

(08.45)

49.2

41.5

Fra

Markit Composite PMI (Nov, Final)

09.50

(08.50)

39.9p

39.9

39.9

Ger

Markit Composite PMI (Nov, Final)

09.55

(08.55)

52.0p

52.0

52.0

EZ

Markit Composite PMI (Nov, Final)

10.00

(09.00)

45.1p

45.1

45.1

EZ

Retail Sales (Oct)

11.00

(10.00)

-2.0%(+2.2%)

+0.5%(+2.6%)

Fri 4th

Ire

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

-6.1%(-3.0%)

+4.0%(-3.1%)

Ger

Factory Orders (Oct)

08.00

(07.00)

+0.5%(-1.9%)

+1.4%(+0.2%)

Ita

Retail Sales (Oct)

10.00

(09.00)

-0.8%(+1.3%)

Gre

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

11.00

(10.00)

-14.0%(-15.3%)

+8.5%(-8.2%)

Selected future data releases and events

Mon 7th

Ger

Industrial Production (Oct)

08.00

(07.00)

+1.6%(-7.3%)

Thu 10th

EZ

ECB Interest Rate Announcement

13.45

(12.45)

-0.50%

-0.50%

*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

+12.6(-4.4)

-3.0(-7.1)

+0.7(-2.8)

+3.0(+13.4)

+2.7(+3.3)

+0.8(+7.3)

+1.3

-7.5

+5.0

+4.0

Household Spending

-12.4(-16.0)

-3.0(-6.7)

+1.5(-0.8)

+3.5(+17.1)

+2.2(+4.1)

+0.7(+8.1)

+1.3

-7.6

+6.8

+3.6

HICP (%y/y)

-0.3 (Oct)

-0.2

0.1

0.7

0.8

1.0

+1.2

+0.3

+0.8

+1.0

Unemployment Rate (%)

8.3 (Sep)

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 (%)

-0.59

-0.50

-0.50

-0.50

-0.50

-0.50

-0.19

-0.50

-0.50

-0.50

$/euro, end period

1.19

1.20

1.21

1.23

1.24

1.25

1.12

1.20

1.25

1.30

£/euro, end period

0.89

0.89

0.89

0.89

0.89

0.89

0.85

0.89

0.89

0.90

Sources: Bloomberg, Capital Economics


Jack Allen-Reynolds, Senior Europe Economist, jack.allen-reynolds@capitaleconomics.com