Still waiting for a shot in the arm… - Capital Economics
European Economics

Still waiting for a shot in the arm…

European Chart Book
Written by Andrew Kenningham

The euro-zone economy is doing better than many expected given that much of the hospitality and travel sector is still closed due to virus-related restrictions. Indeed, the latest business surveys suggest that manufacturing output is growing at a near-record pace. However, this rebound is from a very subdued level and the services sector is still hobbled by Covid-19 restrictions. Overall, we do not expect the euro-zone economy to expand at all in Q2. That said, despite multiple regulatory and logistical problems, the pace of vaccinations has picked up somewhat over the past month. Our best guess is that 50% of adults will have been vaccinated by the end of July. That would allow most restrictions to be lifted during the summer and would pave the way for a sustainable economic rebound.

  • The euro-zone economy is doing better than many expected given that much of the hospitality and travel sector is still closed due to virus-related restrictions. Indeed, the latest business surveys suggest that manufacturing output is growing at a near-record pace. However, this rebound is from a very subdued level and the services sector is still hobbled by Covid-19 restrictions. Overall, we do not expect the euro-zone economy to expand at all in Q2. That said, despite multiple regulatory and logistical problems, the pace of vaccinations has picked up somewhat over the past month. (See Chart 1.) Our best guess is that 50% of adults will have been vaccinated by the end of July. That would allow most restrictions to be lifted during the summer and would pave the way for a sustainable economic rebound.
  • Coronavirus indicators show that the pace of vaccinations is still too slow to meet the EU’s target.
  • Output indicators suggest mobility declined in the past few weeks as new restrictions were announced.
  • Consumer indicators show that household spending remained subdued in Q1 due to the lockdowns.
  • External indicators reveal that the trade surplus narrowed in January.
  • Labour market indicators have continued to defy expectations that the unemployment rate will surge.
  • Inflation indicators show that headline inflation rose further in March, but core inflation fell.
  • Monetary indicators confirm that the ECB has stepped up its PEPP purchases slightly.
  • Fiscal indicators underline that the scale of fiscal support in the EU has been smaller than elsewhere.
  • Financial indicators show that bond yields have stopped rising since the last ECB policy meeting.

Chart 1: New Vaccine Doses Administered (7-day avg per 100 members of the population)

Source: Our World in Data

Coronavirus Indicators

  • New daily cases in the euro-zone surged during March (2). Admittedly, they now look to have peaked and indeed have begun to fall in France, Germany and Italy as a result of additional restrictions (3).
  • However, the number of patients in ICU is at dangerously high levels and is rising steeply in France and Germany (4). In France, it is now at its highest level since last April. The government will be reluctant to lift the restrictions until pressure on the health system has eased (5).
  • Whilst the pace of vaccination continued to pick up in late March (6), we think that hesitancy over the AstraZeneca vaccine, which may potentially be linked to cases of extremely rare blood clots, could impede uptake. Overall, based on an average rate of vaccination of the past four weeks, many European countries would struggle to vaccinate 40% of their adult population by the end of June (7).

Chart 2: Euro-zone Confirmed Infections

Chart 3: New infections in Europe’s Big Four (7-day Ave, per mn pop)

Chart 4: Daily ICU Occupancy

Chart 5: Government Stringency Index

Chart 6: New Vaccine Doses Administered (7-day avg per 100)

Chart 7: Share of Adult Population Given One Vaccine Dose (%, Latest as of 7th Apr.)

Sources: Health Ministries, WHO, Our World in Data, ECDC, CE

Output Indicators

  • Economic activity picked up in March, but it will have remained well below pre-pandemic levels. The Composite PMI rose to an eight-month high in March but we suspect it is overstating the level of output and, in any case, it is consistent with only a small increase in GDP (8). And although the services PMI rose, it is still a long way behind the manufacturing equivalent (9).
  • The manufacturing output PMI reached a record high in March, exceeding its level during the rebound from the global financial crisis. On past form it is consistent with a sharp acceleration in year-on-year growth in industrial production (10). But that is hardly surprising given the collapse in production last year. Services and retail firms have also become more confident (11), but this hinges on the vaccine rollout.
  • Overall business and consumer sentiment is now around its long-run average in the euro-zone, with all the major economies recording an improvement in March (12). But restrictions have been tightened and/or extended in much of the region in April, suggesting the start of Q2 will be weak. Even in Germany, where the economy has been less affected by the lockdowns, the Ifo survey only points to activity stagnating (13).

Chart 8: Euro-zone Composite PMI & GDP

Chart 9: EZ Manufacturing Output & Services PMIs

Chart 10: EZ Mfg Output PMI & Industrial Prod.

Chart 11: Euro-zone Business Confidence By Sector

Chart 12: Major EZ Economies’ ESIs

Chart 13: German Ifo Index & GDP

Sources: Refinitiv, Markit, Capital Economics

Output Indicators (cont.)

  • High frequency data have their limitations, notably that most of them are not seasonally adjusted. This is a particular problem now because the Easter holidays have reduced the number of visits to workplaces and increased visits to retail venues (14). Our CE Mobility Indices suggest that over the past month, mobility has increased in most economies, apart from Italy where restrictions were tightened earlier (15).
  • The new national lockdown in France, as well as tighter restrictions in other countries, are not yet evident in the high frequency data. In Paris, daily congestion data show there were fewer vehicles on the road there after the region was placed in lockdown in mid-March (16). But the drop was not as steep as that recorded last spring. And in Germany, truck toll mileage is above its pre-pandemic level (17).
  • Although the euro-zone economy has adapted to pandemic restrictions, we nonetheless expect the latest measures to mean that it stagnates in Q2. Only by the end of the quarter will governments lift the most economically-damaging restrictions, allowing a rebound in Q3 (18). The pace of recovery could be fastest in Spain, particularly if the government starts to welcome tourists over the summer as it has suggested (19).

Chart 14: Google Mobility Indices

Chart 15: CE Mobility Indices

Chart 16: Traffic Congestion in Paris
(% difference from 2019)

Chart 17: German Truck Toll Mileage
(7-day MA, 1st Mar = 100)

Chart 18: Countries’ GDP Forecasts
(Q4 2019 = 100)

Chart 19: Spain Foreign Tourist Expenditure (€mn)

Sources: Google, INE, Destatis, Refinitiv, CE

Consumer Indicators

  • Covid-19 restrictions are still weighing on consumer spending, but the vaccine rollout means that a recovery is in sight. After contracting by 3% q/q in Q4, household consumption probably fell again in Q1. After all, retail sales fell in January and mobility data show that visits to retail and recreation locations remained weak in February and March (20).
  • What’s more, retail sales account for less than half of total consumption and other spending will have been much weaker. Admittedly, car sales rose in March in the four largest economies (21) and consumer confidence jumped (22) as households’ expectations improved. But confidence remains low by past standards. And French weekly card spending data and restaurant bookings in Germany (23) suggest social spending remained subdued as restrictions were tightened across the euro-zone.
  • Once restrictions are eased – which we expect in June/July – experience from the first wave suggests that confidence and consumption will rebound sharply. But with consumers indicating that they are reluctant to make major purchases and that they plan to save more over the next 12 months (24), total consumer spending is likely to remain below pre-crisis levels for a while yet (25).

Chart 20: EZ Retail Sales & Daily Mobility

Chart 21: Car Registrations (Feb 20 = 100)

Chart 22: Consumer Confidence

Chart 23: Germany In-person Restaurant Diners (% y/y)

Chart 24: EZ Consumer Confidence

Chart 25: Household Spending (Q4 2019 = 100)

Sources: Refinitiv, Open table, EC, CE

External Indicators

  • The outlook for goods exports is relatively bright but the slow vaccine rollout is keeping a lid on services trade. Net trade made a positive contribution to GDP growth in Q4 and is set to do so again in Q1. Admittedly, monthly goods trade data show that the region’s trade surplus narrowed in January, as a fall in exports outpaced that in imports (26). But some of this was due to temporary factors – exports to the UK slumped, mainly reflecting problems with new Brexit rules.
  • Business surveys suggest that goods exports recovered in February and March. The new export orders component of the euro-zone manufacturing PMI rose to a record high of 63.0 in March (27) and was even higher in Germany (28). Admittedly services exports are still falling, even if the pace of contraction is slowing (29) and will stay subdued until the vaccine rollout has made much more inroads.
  • Looking ahead, our forecasts for GDP growth in the euro-zone’s key trade partners suggests that the growth of total exports (including goods and services) will rise sharply in the coming quarters (30). Meanwhile, so long as domestic demand remains weak, and shipping costs high (31), imports will stay subdued.

Chart 26: Goods Trade (€bn)

Chart 27: Manufacturing New Export Orders PMI
& Goods Export Volumes

Chart 28: Manufacturing PMI – New Export Orders

Chart 29: Services PMI – New Export Orders

Chart 30: Euro-zone Goods & Services Exports (Volumes) & Trading Partners’ GDP (% y/y)

Chart 31: Freightos Baltic Container Shipping Index ($)

Sources: Refinitiv, Markit, Capital Economics

Labour Market Indicators

  • The euro-zone’s unemployment rate was stable in February, and while it will probably edge up in the coming months, government support means that it is unlikely to surge. The number of people out of work rose by 48,000, which was not big enough to push the jobless rate up from 8.3% (32). No country saw a big change in its unemployment rate, but there are still big differences between them (33).
  • Besides the headline unemployment rate, there is still plenty of hidden labour market slack in the region. In Italy, for example, the labour force is still around 3.5% smaller than it was pre-pandemic (34). And in the biggest economies, around 5% of the labour force is still benefiting from short-time work schemes (35). Some of those jobs may ultimately not be viable.
  • Meanwhile, firms’ hiring intentions have improved over recent months, but still point on the basis of past form to employment broadly stagnating, rather than increasing (36). Overall, we expect some further job losses over the next couple of quarters, pushing the unemployment rate up a bit (37). But it is then likely to decline steadily as the economy recovers.

Chart 32: Euro-zone Unemployment (%)

Chart 33: Euro-zone Unemployment Rates (%)

Chart 34: Italian Labour Force & Employment (mns)

Chart 35: Short-Time Workers (% of Labour Force)

Chart 36: EZ Firms’ Hiring Intentions & Employment

Chart 37: Euro-zone Unemployment Rate (%)

Sources: Refinitiv, Markit, Capital Economics

Inflation Indicators

  • The increase in headline euro-zone HICP inflation from 0.9% in February to 1.3% in March was in line with the consensus forecast. However, in contrast to consensus expectations, core inflation actually declined, from 1.1% to 0.9%. (32). Much of the increase in the headline inflation rate this year has been a result of rising energy price inflation, a trend which has further to run (33).
  • Inflation has jumped in all the major euro-zone economies this year, but the increase has been highest Germany (34), reflecting a range of one-off factors there, including the end of the temporary VAT cut. Indeed, the HICP inflation rate reached 2.0% in Germany last month, and the alternative CPI measure of inflation also increased sharply (35).
  • Measures of inflation expectations have continued to increase over the past month. However, this seems to reflect US and global developments rather than a genuine increase in expectations for euro-zone inflation (36). Looking ahead, we think the headline inflation rate will probably rise above the ECB’s near-2% inflation target later this year but will drop back again next year (37).

Chart 32: HICP Inflation (%)

Chart 33: Oil Prices & HICP Energy Inflation

Chart 34: HICP Inflation (%)

Chart 35: Germany HICP and CPI Inflation (%)

Chart 36: 5yr/5yr Swaps

Chart 37: Euro-zone Inflation (%)

Sources: Refinitiv, Capital Economics

Monetary Indicators

  • Money growth has accelerated significantly over the past year, with broad money (M3) growth reaching 12.3% y/y in February. Since mid-2020, the biggest contribution has come from the ECB’s asset purchases, as shown by the increase in credit to general government (44). The ECB has stepped up the pace of PEPP purchases since its March meeting (45), though perhaps not as “significantly” as it promised.
  • It is possible that the ECB will exhaust the €1.85trn PEPP “envelope” before next March, which is the earliest date at which net purchases will end (46). Even if it doesn’t, we think the ECB is likely to continue with net purchases throughout 2022. But despite the flexibility within the PEPP, on recent form the Bank seems to be splitting purchases between countries broadly on the basis of the capital key (47).
  • Meanwhile, year-on-year bank lending growth remained fairly high in February (48), but that’s largely due to base effects after the surge in lending from March to May last year (49). So year-on-year lending growth will soon slow. And the latest Bank Lending Survey suggested that banks are tightening their loan standards.

Chart 44: Contributions to Annual M3 Growth (%-pts)

Chart 45: ECB Weekly Asset Purchases (€bn)

Chart 46: ECB PEPP Holdings (€trn)

Chart 47: Difference between Actual Country Share of PEPP Purchases and Share Implied by Capital Key (ppts)

Chart 48: Lending to the Private Sector (% y/y)

Chart 49: Monthly Net Lending
to the Private Sector (€bn)

Sources: Refinitiv, ECB, Capital Economics

Fiscal Indicators

  • Euro-zone governments have continued to issue large volumes of government bonds to finance their deficits (50), which will remain elevated in the first half of the year, at least, because of the continued virus-related restrictions on the economy. The ECB has continued to buy the bulk of the net issuance, effectively financing these deficits (51).
  • The IMF’s latest fiscal forecasts, published this week, are broadly consistent with our own. The Fund expects Germany to bring its deficit back to almost zero by 2023, but deficits in the other large economies to fall to only around 4-5% of GDP (52). Euro-zone governments provided less fiscal support during 2020 than many other advanced-economy governments (53) and many will reduce that support this year (54).
  • Meanwhile, the EU’s joint fiscal programme is yet to begin disbursing any funds. The funds are due to be paid over several years, peaking in 2024 (55). Governments are required to present their national development plans to the European Commission by the end of April. The process may be delayed further by Germany’s constitutional court case, but we still think some funds will start to flow in Q3.

Chart 50: EZ Net Gov’t Bond Issuance (12m sum €bn)

Chart 51: EZ Net Government Bond Issuance & ECB Bond Purchases (€bn)

Chart 52: General Government Balance (% of GDP)

Chart 53: Change in Structural General Government Balance (2020, % GDP)

Chart 54: Change in Structural General Government Balance (2021, % GDP)

Chart 55: Disbursement of RRF Grants (€bn, ECB Est.)

Sources: Refinitiv, Eurostat, ECB, EC, CE.

Financial Indicators

  • Government bond yields have been dragged up this year by the sell-off in the US Treasury market, but they have stopped increasing since the ECB’s meeting on 11th March when it announced that it would step up the pace of its asset purchases in the coming quarter (56). Investment grade corporate bond yields have also stopped rising, while the yields of corporate bonds with lower credit ratings have fallen (57).
  • We suspect that any further increases in Bund yields will be small. The ECB looks set to leave policy rates at record low for some time, and longer than investors generally expect (58). Moreover, we think the Bank will continue with net PEPP purchases until the end of next year. Inflationary pressures are also lower in the euro-zone than in other advanced economies, so inflation compensation is less likely to keep rising (59). Improved global risk appetite could even drive bond spreads lower.
  • We forecast that bond yields will rise further in the US than euro-zone, which suggests that the euro will weaken (60). Finally, although we expect the US economy to outperform the euro-zone, the sectoral composition of the US equity market, and the possibility of tax cuts, will weigh on US equity indices. So we forecast similar gains in Germany to the US over the rest of the year (61).

Chart 56: Changes in 10-year
Government Bond Yields (%)

Chart 57: Euro-zone Corporate Bond Yields
(ICE indices, %)

Chart 58: ECB Deposit Rate
& Path Implied by OIS Rates (%)

Chart 59: 10-year Inflation Swap
& Bund Breakeven Inflation Rate (%)

Chart 60: US Dollars per Euro

Chart 61: Equity Indices (1st January 2020 = 100)

Sources: Refinitiv, Capital Economics

Andrew Kenningham, Chief Europe Economist,
Jack Allen-Reynolds, Senior Europe Economist,
Melanie Debono, Europe Economist,
Jessica Hinds, Europe Economist,
Oliver Byrne, Research Assistant,