Summary:
• The impact of COVID-19 led to a recession of historic proportions in the eurozone in the first and second quarters of 2020 due to the introduction of restrictions and lockdown measures, which brought part of the economy to a standstill. The gradual lifting of these measures was followed by a rapid rebound in activity since May, although signs of a slowdown have appeared since August, particularly in the southern eurozone countries.
• Compared to previous crises, the combination of the policy mix (a combination of accommodative fiscal and monetary policies) and a more resilient banking sector than before could enable a faster return to pre-crisis levels of activity.
• The household savings rate in the eurozone has doubled, rising from 12% of gross disposable income in Q4 2019 to 24% in Q2 2020. This unprecedented peak in the savings rate is the result of lockdown measures that prevented households from consuming, while their incomes were largely preserved by the implementation of automatic stabilizers. One of the key challenges for economic recovery is how to mobilize these « forced savings. » If they turn into more precautionary savings, it could hurt household confidence and consumption.
• Despite the scale of the crisis, the labor market has shown resilience, with companies making extensive use of the partial activity schemes put in place or extended in many countries. Nevertheless, the gradual lifting of these measures will lead to a delayed deterioration in the labor market.
Usefulness of the article: This article reviews the scale of the Covid-19 crisis in the eurozone. It also highlights the importance of economic agents’ expectations in the recovery of economic activity.
After experiencing a historic recession in the first half of the year, the Eurozone saw a rebound in economic activity, which is now threatened by the risk of a second wave and restrictive measures that could once again penalize economic activity.
1. Economic recovery: the rebound that began in May is showing signs of running out of steam
The evolution of economic activity in the eurozone since the start of the pandemic can be broken down into three distinct periods:
(1) the partial (or total in some sectors such as culture, events, hotels/restaurants, and transportation) shutdown of economies between March and May during the lockdown period;
(2) the stronger-than-expected rebound in activity between May and July following the improvement in the health situation and the lifting of restrictions; and
(3) the emergence of signs suggesting that the recovery has been losing momentum since the beginning of September, linked to the epidemic and the reintroduction of restrictive measures.
Phase 1: The Covid-19 shock led to a historic contraction in activity in the eurozone in the first and second quarters of 2020 due to the introduction of restrictions and lockdown measures (Charts 1 and 2), which brought part of the economy to a standstill (-3.7% quarter-on-quarter – QO – in Q1 2020 and -11.8% QO in Q2). Over the first half of 2020 as a whole, the fall in activity stood at -15.1% compared with Q4 2019.
Phase 2: As restrictions were gradually lifted, economic activity began to recover in May. The lifting of lockdown restrictions has enabled a rapid rebound in much of the economy through a recovery in household consumption (Figure 2) and, to a lesser extent, a recovery in investment. This rebound in activity has been supported by monetary (see Pinter, 2020) and fiscal support measures, which have helped to limit the scale of the crisis. Measures to support corporate cash flow, most often through credit guarantees for businesses (see Brault, 2020), prevented numerous defaults, while short-time working schemes, which were introduced or strengthened in many countries, limited income losses for households and job losses.
Phase 3: Since the end of the summer, the economic recovery in the euro area has begun to show signs of slowing down, due to the deterioration in the health situation (Chart 3) and the reintroduction of restrictive measures. The industrial sector is showing some resilience, reaching a level of activity in July that was 95% of the December 2019 level (Chart 2), with industrial confidence returning to pre-crisis levels. However, activity in the services sector (tourism, hotels/restaurants, events) appears to have slowed again in the eurozone in September, according to PMI surveys, which indicate a contraction in services, while those of the European Commission remain slightly less pessimistic and suggest a more gradual recovery (Chart 4).
The final PMI activity indices for September confirmed that controlling the epidemic remains a major economic challenge. Countries that have had to implement new, stringent restrictions have seen their PMI indices return to contraction territory (below 50). Spain is the most striking example, with a sharp decline in its index in September (44.3 after 48.4 in August), as the government has imposed local lockdowns (particularly in part of the Madrid region) since the end of August. Germany is outperforming its neighbors, thanks in particular to its better control of the epidemic. The resurgence of the epidemic and the reintroduction of restrictive measures suggest a slowdown in the recovery of economic activity. The Bloomberg consensus forecast is for growth of 8.4% in Q3 and only 2.3% in Q4 2020.
According to projections by major institutions (Eurosystem, OECD) published in September, eurozone growth is expected to decline by around 8% in 2020. Although several eurozone economies are now operating at close to 95% of their pre-crisis levels, a return to pre-crisis levels may not occur until 2022, or even 2023 for some countries such as Spain (see the Bank of Spain’s macroeconomic projections).
In a recent article, De Grauwe P. and Yuemei Jiont compared the Covid-19 crisis with those of 1929 (Great Depression) and 2008 (Great Financial Crisis). They observe that the current crisis has led to both negative supply and demand shocks, resulting in an unprecedented contraction in industrial production. However, the combination of accommodative fiscal and monetary policies and a banking sector that, although still fragile, is more resilient than before has enabled a faster rebound in economic activity following the coronavirus shock than in the two previous major crises.
2. Household savings and delayed deterioration in the labor market
The household savings rate in the euro area doubled, rising from 12% of gross disposable income in Q4 2019 to 24% in Q2 2020 (Chart 5). This unprecedented peak in the savings rate is the result of lockdown measures that prevented households from consuming, while their incomes were largely preserved by the implementation of automatic stabilizers. One of the key challenges for economic recovery is how to mobilize these « forced savings. » If they turn into more precautionary savings, it could hurt household confidence and consumption (Chart 6).
Despite the scale of the crisis, the labor market has shown resilience, with companies making extensive use of the partial activity schemes introduced or extended in many countries. As a result, the adjustment of employment to the shock to economic activity remained fairly limited in the first half of 2020, with job losses concentrated in temporary employment and the non-renewal of short-term contracts. Employment fell by 2.9% in Q2 2020 in year-on-year terms, after -0.3% in Q1 2020 in year-on-year terms, and the unemployment rate in the eurozone (expressed as a percentage of the labor force) rose only from 7.2% in March to 7.9% in July. The shock to employment was mainly cushioned by the introduction of short-time working measures, which acted as an automatic stabilizer. Data and estimates from national statistics institutes, the OECD, and the ECB show that at the peak of Covid-19 (April-May), around 20% of all employees were on short-time work in Germany and Spain, while in Italy and France, the proportion of employees on short-time work peaked at 35-40%, representing more than 25 million people in the four main eurozone countries. The labor market will deteriorate in the coming months with job losses in companies in difficulty or bankruptcy, which will have a direct impact on the employment rate.
Young workers will be the first to be affected by the deterioration of the labor market (see S. Nevoux, 2020). According to a study by the International Labor Organization, the pandemic will have a « devastating and disproportionate » impact. In addition to the long-term challenges that exist in integrating young workers, the COVID-19 crisis is severely affecting young people in three ways: (1) disruption to education and training, which could reduce opportunities for qualifications, employment, and future income; (2) the current wave of job losses and rising business failure rates, which also have an impact on future employment and income; and (3) the emergence of greater barriers to finding employment and integrating into the labor market. More specifically, some people have been laid off during their probationary periods in the recent period, while others are finding it difficult to enter the labor market. Indeed, many companies that have slowed down their investment may significantly reduce their recruitment of young people.
