Virus restrictions continue, ECB provides more support - Capital Economics
European Economics

Virus restrictions continue, ECB provides more support

European Economics Weekly
Written by Jessica Hinds

The extension of virus restrictions in France and calls for tougher measures in Germany this week strengthen our view that euro-zone economic activity will still be substantially curtailed in early 2021. But the ECB’s additional policy measures and the resolution of the EU budget dispute mean that both monetary and fiscal policy will be supporting the recovery once the vaccine rollout allows for restrictions to be lifted in Q2.

This week has brought little festive cheer on the virus front, with France announcing that with daily new infections no longer falling rapidly, many of the restrictions will stay in place for three more weeks, with an 8pm curfew only lifted for Christmas Eve. Meanwhile, Angela Merkel, who has called for a much stricter lockdown in Germany in the run-up to Christmas, is expected to discuss new measures with state leaders on Sunday. Overall, this strengthens our view that significant restrictions will be in place during early 2021, meaning that the euro-zone economy will start the year firmly on the back foot.

ECB “recalibrates”…

Given the certain slump in economic activity in the fourth quarter, yesterday’s dovish message from the ECB came as no surprise. The raft of measures announced was very much in line with what senior policymakers had already been signalling: the Bank increased the Pandemic Emergency Purchase Programme by €500bn and will continue buying assets until at least March 2022, and it will offer three further rounds of targeted loans to banks.

The key message was that monetary policy would remain very loose for a long time yet. This was supported by new, gloomier forecasts for growth in the near term and an inflation forecast that showed the headline rate at just 1.2% in 2023, which even the Bank’s uber-hawks would struggle to argue is anywhere near the “below, but close to, 2%” target.

Since the press conference, Governing Council members have been stressing the flexibility of the PEPP, with French central bank governor François Villeroy de Galhau stating on Friday morning that the ECB would adjust how much it buys depending on financing conditions. And unlike Christine Lagarde, he was explicit on talking down the euro, arguing, “we have a strong vigilance” about the effect of the exchange rate on inflation. That has helped to knock the euro down a bit this morning, although we doubt that ECB rhetoric will prevent a gradual appreciation over the next year or two.

With the ECB committed to buying assets for a good while yet, we strongly doubt that there will be any reversal of the yield compression that we have seen since March. Indeed, the Portuguese 10-year government bond yield is now negative for the first time, while the Spanish equivalent is sitting only just above zero. (See Chart 1.) The ECB backstopping the market is a key reason why we expect peripheral yield spreads to fall a little further next year and stay low in 2022. (See our Global Markets Focus here.)

Chart 1: 10-Year Government Bond Yields (%)

Sources: Refinitiv, Capital Economics

… as EU leaders deliberate

EU leaders have also been meeting, and the dispute with Hungary and Poland over the bloc’s budget has been at the centre of discussions. As we suspected was likely given the money at stake, a deal was done and announced on Thursday evening. This is a positive step and means that the EU can now get the Recovery Fund up and running and start disbursements to countries from the second half of next year. If used fully, the funds could provide a meaningful boost to GDP. But the amounts will be small compared to the increase in debt that many countries will have racked up, so will have little impact on debt dynamics.

The week ahead

Next week sees the publication of the business surveys for December, with the flash PMIs likely to have been broadly unchanged as strict restrictions are extended. Meanwhile, country-level data suggest euro-zone industrial production rose in October.


Data Previews

Euro-zone Industrial Production (Oct.) Mon. 14th Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Industrial Production m/m (y/y)

10.00

-0.4%(-6.8%)

+1.8%(-4.4%)

+2.0% (-3.9%)

Industry holding up well

Industrial production almost certainly rose in October and is likely to hold up reasonably well in Q4 as a whole.

Euro-zone industrial output edged down at the end of Q3 but this was largely due to temporary effects in Italy. However, we already know that production increased in most euro-zone countries in October. German industrial production rose by 3.4% m/m, driven by a jump in auto production. Output also rose in France, Spain, Italy and Portugal and was unchanged in Ireland. Putting these data together, we estimate that euro-zone industrial output rose by 2.0% m/m. This would leave output around 4% below February’s level.

We think that industrial production should remain resilient in November and December. The national and regional lockdowns which are now in force are more narrowly targeted than in the first wave and should allow manufacturing to continue more or less unscathed. That said, survey data suggest that the period of rapid recovery is now coming to an end. (See Chart 2.)

Chart 2: Manufacturing Output PMI & Industrial Production

Sources: Refinitiv, Markit, Capital Economics

Euro-zone Flash Composite PMI (Dec.) Wed. 16th Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Composite PMI

09.00

45.3

45.5

45.5

PMIs to remain well below 50

Continued strict virus containment measures will keep the PMIs well below 50 in December.

Lockdowns in Germany and France have been extended, so their PMIs are unlikely to have changed very much. In Italy, lower virus numbers have allowed the authorities to relax restrictions and now no regions are in the highest tier of its three-tier system. But at the euro-zone level, any improvement in activity is likely to be small. The current conditions indices of the Sentix and ZEW investor surveys were little changed in December. (See Chart 3.) And for the PMIs, if the usual Christmas-related bounce in activity is smaller than usual, then the seasonal adjustment might cause the activity indices to fall.

On balance, we have pencilled in a broadly unchanged Composite PMI of 45.5 for December. More forward-looking indicators have improved since the first Pfizer vaccine announcement in early November, including the future output PMI and the sentiment indices of the Sentix and ZEW surveys. We think that after contracting in Q4 and treading water in Q1, the relaxation of virus rules will allow the euro-zone economy to rebound strongly.

Chart 3: Current Conditions Indices

Source: Refinitiv

Euro-zone Hourly Labour Costs (Q3) Wed. 16th Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Hourly labour costs (y/y)

10.00

(+4.2%)

(+2.0%)

Hourly labour costs growth slowed even as economy rebounded

We suspect hourly labour cost growth slowed in Q3, as compensation rose less than hours worked.

In the first half of the year, lockdowns shuttered large parts of the economy and many workers were put on short-time working. As a result, hours worked plunged more sharply than compensation, causing total hourly labour cost growth to jump.

Differences in how short-time work scheme payments are distributed mean that they are classified differently for labour costs statistics and, as a consequence, makes forecasting what happened to euro-zone hourly labour costs quite difficult.

We know that total employee compensation rose in Q3, by 8% q/q. But we also know that hours worked rose more sharply, by 14.8% q/q. This suggests that hourly labour cost growth slowed. The fall in German hourly unit labour cost growth points to annual euro-zone hourly labour cost growth slowing to 2-2.5%. (See Chart 4.) We have pencilled in a 2% y/y rise in total (wage and non-wage) hourly labour costs in Q3, much less than in Q2.

Looking ahead, labour costs growth looks set to slow further. As furlough schemes are made less generous, total hours worked will continue to increase while, faced with weak demand, firms will cut their wage bills by letting go of some workers.

Chart 4: German Hourly Unit Labour Costs & Euro-zone Hourly Labour Costs (% y/y)

Source: Refinitiv

German Ifo Survey (Dec) Fri. 18th Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Business Climate Index for Germany

09.00

90.7

89.8

88.0

Lockdown-lite dragging on sentiment

We suspect that the Ifo Business Climate Index (BCI) dropped further in December as the extension of containment measures weighs on the services sector.

In November the BCI fell, from 92.5 in October to 90.7, as both the expectations and current business situation indices deteriorated. The rise in the manufacturing sub-component was more than offset by a sharp reversal of the services and wholesale and retail trade components.

While manufacturing is likely to have held up well once again, we suspect that the services component will have fallen even further. While Germany has not tightened restrictions again, it has extended its lockdown-lite into January which is likely to weigh on firms’ activity and expectations. While the ZEW and Sentix indices for December rose, they measure sentiment and not activity as the Ifo does. We have pencilled in a fall in the BCI to 88. This would take the index further below February’s level (95.8) and, on past form, pointing to GDP contracting in y/y terms in Q4. (See Chart 5.)

Chart 5: Ifo BCI & Germany GDP

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 14th

Fin

CPI (Nov, EU Harm)

07.00

(06.00)

+0.2%(+0.5%)

EZ

Industrial Production (Oct)

11.00

(10.00)

-0.4%(-6.8%)

+1.8%(-4.4%)

+2.0%(-3.9%)

Tue 15th

Fra

CPI (Nov, Final, EU Harm)

08.45

(07.45)

+0.2%(+0.2%)p

+0.2%(+0.2%)

+0.2%(+0.2%)

Ita

CPI (Nov, Final, EU Harm)

10.00

(09.00)

-0.1%(-0.3%)p

(-0.3%)

-0.1%(-0.3%)

Ita

Trade Balance (Oct, sa)

11.00

(10.00)

+€7.1bn

EZ

ECB’s Lane speaks at ECB forum

15.00

(14.00)

Wed 16th

Aus

CPI (Nov, EU Harm)

09.00

(08.00)

+0.2%(+1.1%)

Fra

Markit Composite PMI (Dec, Prov)

09.15

(08.15)

40.6

41.3

40.6

Ger

Markit/BME Composite PMI (Dec, Prov)

09.30

(08.30)

51.7

50.8

51.7

EZ

Markit Composite PMI (Flash, Dec)

10.00

(09.00)

45.3

45.5

45.5

EZ

Markit Services PMI (Flash, Dec)

10.00

(09.00)

41.7

41.0

42.0

EZ

Markit Manufacturing PMI (Flash, Dec)

10.00

(09.00)

53.8

53.0

53.5

EZ

Hourly Labour Costs (Q3, q/q(y/y))

11.00

(10.00)

+3.9%(+4.2%)

(+2.0%)

EZ

Trade Balance (Oct, sa)

11.00

(10.00)

+€24.0bn

EZ

Virtual Eurogroup Meeting

14.00

(13.00)

EZ

ECB’s Schnabel speaks at HIS

17.15

(16.15)

Thu 17th

Fra

INSEE Business Confidence (Dec)

08.45

(07.45)

79.0

Swi

Interest Rate Announcement

09.30

(08.30)

-0.75%

-0.75%

-0.75%

EZ

ECB’s Schnabel speaks with German Min. Fin.

17.00

(16.00)

Fri 18th

Ger

PPI (Nov)

08.00

(07.00)

+0.1%(-0.7%)

+0.1%(-0.6%)

Ger

Ifo (Dec)

10.00

(09.00)

90.7

89.8

88.0

Spa

Trade Balance (Oct, sa)

10.00

(09.00)

-€0.6bn

Selected future data releases and events

Mon 21st

EZ

Consumer Confidence (Dec, Flash)

16.00

(15.00)

-17.6

Wed 23rd

Spa

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

09.00

(08.00)

+16.7%(-8.7%)p

+16.7%(-8.7%)

Thu 24th

Net

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

06.30

(05.30)

+7.7%(-2.5%)p

+7.7%(-2.5%)

Also expected during this period:

27th – 5th

Ger

Retail Sales (Nov)

+2.6%(+8.2%)

*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

0.2

0.9

1.1

1.2

+1.2

+0.3

+0.8

+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 (%)

-0.63

-0.50

-0.50

-0.50

-0.50

-0.50

-0.19

-0.50

-0.50

-0.50

$/euro, end period

1.21

1.20

1.21

1.23

1.24

1.25

1.12

1.20

1.25

1.30

£/euro, end period

0.92

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