European economic resilience in 2021: why a brighter second-half is taking shape

29 January 2021

Giovanni ZanniChief Euro area Economist

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5 minute read

How will new lockdowns introduced or strengthened across Europe in recent weeks affect the medium-term economic outlook? In this quick-take article, Giovanni Zanni explores the roots of Europe’s economic resilience and outlines three key reasons why a brighter second-half awaits corporate finance decision-makers & treasurers.

Stronger coronavirus restrictions taking shape across Europe in December had initially tempered our medium-term growth expectations, but the latest round of surveys & data releases suggest economic activity in the final quarter of 2020 wasn’t as weak as initially feared. Although we still believe responses to the pandemic will continue to drive economic differentiation & divergence in Europe and elsewhere (a theme we explore further in this article from our Year Ahead series), overall, the short-term challenges continue to appear outweighed by the positive prospects ahead.

Signs of economic resilience in the fourth quarter – led by Germany

Business sentiment and activity are improving across much of Europe. The December euro-area manufacturing purchasing manager’s index (PMI), a monthly survey of supply chain managers and a broad measure of the direction of economic sentiment & activity, reached 55.2 – its highest level since May 2018 – which suggests industrial activity is making up for ground lost in the early months of 2020 (a score above 50 signals expansion). In terms of actual output, investment goods were particularly buoyant, while consumer goods recorded only a marginal gain (but a gain nonetheless).

Country-wise, Germany is leading the pack – helped by its large manufacturing base (and export exposure: global trade is rebounding fast), VAT discounts and lighter (at least until recently) lockdown measures. Industrial orders rose significantly more than expected in the fourth quarter – exceeding pre-crisis levels and pointing to strong demand (especially from abroad). This is coupled with positive developments in a host of other areas (see chart below), all of which point to further improvement in the months ahead and greater resilience than initially expected.

German indicators – all looking up

Sources: National Statistics Agencies, NatWest Markets

First-half challenges: storm before the calm

Despite fledgling signs of resilience across the euro area, there is reason to be cautious about the months ahead. Governments, businesses & markets may have learned to live with the virus, to some extent, but the recent acceleration in cases will inevitably slow the pace of a return to normality.

Overall, while the decline in Q4 2020 growth may be less dire than our November -3% quarter-on-quarter projection, output will likely remain broadly negative through the end of Q1 2021. This is partly down to the outlook for services: the euro-area services PMI was also up in December, but it remains at 46.4, well below growth territory, reflecting a weak start in 2021.

That said, varied approaches to lockdowns across Europe (and elsewhere) have driven – and will continue to drive – economic differentiation, a theme we explored in a recent Year Ahead episode of the On Point podcast (listen here). As the chart below suggests, France suffered in the fourth quarter last year despite an impressive rebound three months prior, partly because of a sharp rise in cases prompted a much harder lockdown than seen elsewhere (and unlike Germany, France didn’t benefit from a VAT cut incentive).

Retail sales: coronavirus and VAT are driving differentiation

Sources: Eurostat, NatWest Markets

The case for a swift second-half growth recovery remains

We think there are three key reasons why growth is still likely to accelerate in the second half of the year.

  • Businesses are optimistic: the outlook captured by a wide range of business surveys across the region is at multi-year highs, with companies believing in (and very likely preparing for) the recovery.
  • Falling savings and higher consumer spending: there are signs from (primarily French) consumers that the excess savings accumulated in 2020 will be at least partially spent in 2021. Indeed, they point to a reduced opportunity to save and to an increase willingness to buy large ticket items
  • Expansionary fiscal and monetary policy: both monetary and fiscal policy will remain expansionary, gaining another boost when the EU Recovery Fund kicks in from late 2021 and into early 2022.

Overall, the short-term challenges continue to appear outweighed by the positive prospects ahead.

For questions on this article, get in touch with your NatWest corporate & institutional representative or contact us here.

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