September 25, 2023

Europe Economic Forecast for Spring 2020 : Recession & Uncertain Recovery

The COVID-19 pandemic and the containment measures it has necessitated have profoundly disrupted people’s lives and the economy. Global demand, supply chains, labour supply, industrial output, commodity prices, foreign trade and capital flows have all been affected.

Real-time data suggest that economic activity in Europe has dropped at an unusually fast speed over the last few weeks, as the containment measures triggered in response to the crisis by most Member States in mid-March have put the economy into a state of hibernation.

Under these benign assumptions, EU GDP is forecast to contract by about 7½% this year, far deeper than during the Global Financial crisis in 2009, and to rebound by only 6% in 2021.

The COVID-19 crisis is a symmetric shock hurting all Members States. Their strong economic interconnectedness is magnifying the aggregate demand and supply shocks. While the recovery looks set to be incomplete in almost all countries, the impact of the crisis and the way Member States will emerge from it is set to be uneven.

Due to strong interdependencies of well countries  an incomplete recovery in one country would spill over to all the other countries and dampen economic growth everywhere.

As the COVID-19 virus spread around the world, many governments were forced to take extreme precautionary public health measures to save lives and prevent health care systems from being overwhelmed. These measures made it impossible for economic life to continue normally, effectively shut down large portions of the economy and derailed the incipient bottoming out in the global economy that had started to emerge around the turn of the year.

Lending support from the banking sector will be vital, not only during the crisis, but also during the economic recovery. But banks are particularly exposed to the economic recession as more borrowers are likely to default and because the prices of securities on their balance sheets have taken a beating.

All demand components will be hit hard by the pandemic except government consumption and public investment, which are playing a stabilising role.

Moreover, uncertainty about employment and income prospects will likely ensure that precautionary savings remain higher than they were before the crisis well after the lockdowns have ended.

Euro area exporters already suffered last year from weakening foreign demand largely reflecting trade tensions and elevated trade policy uncertainty. Since the pandemic, the halt in the free movement of people, goods and services is set to result in a sudden, severe and synchronised drop in external demand. The euro area is expected to be particularly affected due to its relatively high participation in global and intra-EU value chains. Euro area exports are thus forecast to fall by about 13% in 2020 before rebounding incompletely by close to 10% in 2021. A stronger catch-up is unlikely due to enduring weakness of foreign demand, likely delays to the resumption of production and supply chain normalisation, as well as still elevated levels of uncertainty. As exports and imports are expected to move almost in parallel, the contribution of net exports to GDP growth in the euro area and the EU should be relatively small this year and next.

The COVID-19 pandemic and the confinement measures it has necessitated have led to significant disruptions and completely changed the prospects of European labour markets that were, up to early 2020, the bright spot in the expansion years.

The euro area unemployment rate is expected to increase from 7.5% last year, its lowest level in more than a decade, to about 9½% this year and to decrease next year while remaining well above its pre-pandemic level in 2021. Unemployment rates are expected to rise very differently across the EU, not only because of the size and effectiveness of policy measures, but because of pre-existing vulnerabilities (e.g. high share of temporary contracts) and different sector specialisations (e.g. tourism).

Overall, the pandemic is likely to put downward pressure on prices because the effect of lower demand will outweigh price increases sparked by supply chain disruptions. This has already been signalled by recent developments in euro area inflation.

Inside the EU, the pandemic could also leave permanent scars, such as a large number of bankruptcies and higher hysteresis effects in the labour market, that are not taken into account in the baseline scenario.

The risk also remains that new tariffs might be applied, which could adversely affect business investment plans. Moreover, reaching the end of the transition period foreseen in the Withdrawal Agreement between the EU and the UK will dampen economic growth, even if a free trade agreement between the EU and the UK is concluded. This will affect particularly the UK, but also the EU, albeit to a lesser exten

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