A Massive Economic Shock
According to the latest forecasts by the International Monetary Fund (IMF), Gross Domestic Product (GDP) is expected to contract by 3% in 2020. The vast majority of world regions will be hit hard, and the euro area is no exception. According to the IMF, the fall in eurozone GDP in 2020 will be historic (-7.5%), even sharper than in 2009 (-4.5%).
The pandemic has induced a triple-pronged economic shock:
- a supply shock, due to the closing of industrial plants and a shortage of workers going to their workplace,
- a demand shock, with household consumption expected to drop mechanically as a result of lockdown restrictions in European countries and the closing of many stores,
- the existence of many uncertainties, e.g. those surrounding the duration of lockdown measures, the vigour of future demand and the effectiveness of economic stimulus measures.
This may deter businesses from investing while encouraging precautionary saving by households. According to some estimates, lockdown measures may, overall, cause a loss of economic activity of about 30% compared with a normal, no-lockdown situation, although that percentage varies from country to country.
The latest economic indicators and data provide the first indications of the magnitude of the economic consequences of the Covid shock. The current crisis and sanitary measures are challenging for the production of statistics. At this point, the latter must be thus interpreted with cautious. In first quarter 2020, GDP for the euro area fell by 3.8% compared to Q4 2019 (quarterly variations). Although it remains difficult to compare the economic performances of eurozone member States, it would appear that, so far, Germany has better withstood the shock than its major European neighbours. For Q1 2020, GDP in Germany was down by 2.2% compared, for instance, to France (-5.3%) or Italy (-5.3%).
Uncertain Economic Rebound in H2 2020
In Q2, the adverse impact on euro area economies is expected to be much greater, because lockdown restrictions were in place during much of this period. The leading indicators of economic activity, which reveal a great deal about the economic outlook, are sending very unfavourable early warning signals. One frequently used leading indicator is the Purchasing Managers Index (PMI). Based on a survey of supply chain managers, the PMI gives an accurate picture of the economic health of different sectors (manufacturing, services and construction) and is well correlated with quarterly GDP growth for the euro area. In April 2020, the PMI for the services sector reached its lowest point since the eurozone was created. In May, the downtrend seems to have stopped, but activity remains particularly weak. Highly dependent on private consumption, the services sector is one of the sectors hit hardest by the current crisis. In particular, retail, transportation and accommodation businesses have been hugely impacted by the sanitary measures taken to curb the epidemic. Judging by the PMI, the decline in manufacturing activity, although not as severe, also appears to be very substantial. Moreover, the rapid, widespread erosion of consumer confidence in April could be a determining factor for economic recovery in the months to come.
The profile of the economic rebound in the euro area in second half of 2020 remains very unclear. It may not be possible to make up for lost economic activity to the extent initially anticipated. The European Central Bank (ECB) recently noted that, in a worst-case scenario, GDP – in real terms, i.e. adjusted for price – could fall by 12% in 2020 and remain below its pre-crisis level for several years. One of the important unknowns is the development in household consumption. During lockdown, European households accumulated a great deal of savings at a time when their consumption was greatly restricted and their incomes were more or less maintained, notably due to the implementation of short-time working schemes. However, consumers may refrain from spending all of their surplus savings. Even though strict lockdown restrictions have been lifted, preventive measures such as social distancing could continue to put a damper on household spending. Given the high level of uncertainty surrounding the evolution of the epidemic and in the labour market, households may decide to postpone purchases and continue to moderate their consumption. If these precautionary behaviours persist, they could hinder economic recovery in the euro area.
Large-scale public-sector support
Faced with this massive economic shock, public authorities have taken proactive measures to stimulate the economy and help it recover as strongly as possible. Governments have made ample use of short-time working schemes and provided guarantees to cover business loan repayments. The ECB has taken a number of decisions to ease lending conditions. The scale of these measures should limit, at least in the short term, the risk of seeing a tightening of financial conditions in the euro area. If difficulties were to arise in the banking and financial sector, the economic consequences could last significantly longer.
