Europe’s macroeconomic recovery projections post-COVID-19

By Noelle Micallef

The ongoing coronavirus (COVID-19) pandemic continued to impact economic activity in the first quarter of 2021. Elevated uncertainty and containment measures persisted and weighed on supply and demand. Having said this, substantial measures taken by central banks and governments continue to support the economy and a number of economic measures indicate ongoing recovery. Then again, the Delta variant of COVID-19 could dampen this recovery.

According to Eurostat, real GDP in the Euro Area declined by 0.3% in the first quarter of 2021, with real GDP in this quarter being 5.1% below its level in the fourth quarter of 2019. The June 2021 Eurosystem staff macroeconomic projections show that following a contraction of 6.8% in 2020, real GDP is set to expand by 4.6% in 2021 and 4.7% in 2022, before moderating in 2023 to 2.1%, as indicated in the table below. This implies that real GDP is expected to exceed its pre-crises level in the first quarter of 2022 (one quarter earlier than expected in the March 2021 projections). Real GDP should stand at 1.3% below the level expected in the projections published before the start of the pandemic in the final quarter of 2022.

Growth and inflation projections for the euro area (annual percentage changes)Source: Eurosystem staff macroeconomic projections for the euro area, June 2021

The rebound is expected on the basis of several assumptions, namely, a further decline in uncertainty, increased relaxation of containment measures, supportive fiscal (including the Next Generation EU programme) and monetary policies, and further increases in vaccination rates; all of which contribute to boosting demand. The new Delta variant of the coronavirus is driving a rise in cases in a number of countries, however, European countries with relatively high vaccination rates have so far experienced limited increase in COVID-19 cases, particularly with respect to hospitalisations. Overall, a large financial amplification effect has so far been avoided via monetary, fiscal and macroprudential policy measures.

The key driver of the recovery is expected to be private consumption, as uncertainty relating to the pandemic is expected to decline gradually, and also due to a recovery in disposable income. After a fall of 2.2% in private consumption in the first quarter of 2021, quarter on quarter, consumer spending appears to have strengthened in the second quarter. This increase is largely attributed to households’ improving expectations about the general economic situation. In the long term, as the economy recovers, labour income should contribute further to total household income, thereby reducing the economy’s dependence on fiscal support. Although private consumption is expected to be the key driver of the recovery, the significant stock of accumulated excess savings is expected to remain largely unspent, and therefore the baseline does not envisage a strong contribution from unleashed pent-up demand.

The June 2021 projections expect inflation to spike at 1.9% in 2021, before returning to rates of 1.5% and 1.4% in 2022 and 2023 respectively once demand pressures remain subdued and as a decline in oil prices is assumed. The large increase in headline inflation in 2021 reflects several factors, namely, the reversal of the German VAT rate cut, the rebound in the energy inflation rate and an increase in input costs related to supply disruptions. Inflation is projected higher than that projected in March 2021, as the past quarter has indicated positive developments in slack and upward effects from commodity prices.

The support provided by euro area governments during the COVID-19 crisis has so far prevented any major disruptions to the economy. Risks from further capital injections may materialize, depending on the depth and duration of the pandemic. As the recovery gains momentum, it is imperative that sectors and firms are relieved from government exposures and that economies reduce their dependence on official support.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.