COVID-19 And The Eurozone Economies In 2021: Darkest Before Dawn?  

The eurozone economy will continue to be dominated by the coronavirus, much as in 2020. Optimism prevails for the latter part of the year though as vaccinations are expected to boost economic recovery. Don’t expect the ECB to remove support quickly though.

With lockdowns extended into the new year, it really feels like it is darkest before dawn in the eurozone. In the first quarter, GDP is all but certain to contract again and the question is now by how much. Vaccination programmes have started off slowly, but are expected to pick up speed once teething troubles are smoothed out. We expect the combination of lockdowns and vaccinations will allow for more substantial reopening of economies over the course of the second quarter. This will then also mark the start of the recovery of the eurozone economy.

The recovery will pick up steam once vaccinations are more widespread and the virus retreats more permanently. For the second half of the year, that will likely result in a strong growth recovery, further boosted by the Recovery and Resilience Fund that will start to disburse grants to EU countries. This will coincide with a period of stronger inflation, which is partly mechanical. Energy inflation will be higher on the back of a reversal of the oil price decline seen in March last year and the German VAT decrease of last year is not renewed. Social distancing price categories are also likely to make up for discounts given during coronavirus times, which makes a temporary surge to around 2% a possible scenario.

The ECB is not expected to reduce support quickly as the economy recovers. While inflation could temporarily tick higher, the ECB is focused on the medium-term inflation outlook for its policy making and the medium-term outlook is not improving much. In fact, with unemployment trending somewhat higher and output gaps very negative, it is likely that it will take longer than expected pre-crisis before inflation is sustainably returning to just below 2%. The pandemic emergency purchase programme (PEPP) has already been announced to run until spring 2022 and early tapering is unlikely to become a theme for this year. There is huge uncertainty surrounding this base case though, which makes it worth looking at other possible scenarios as well. Given the importance of vaccine rollouts and lockdowns for the economy, those are the drivers of the various scenarios we look at.

  • A more optimistic take would be one in which lockdowns succeed in bringing down new cases very substantially and improved testing capability compared to the first wave allows new cases to be kept at a very low level. This, together with a speeding up of vaccination efforts that inoculates the vulnerable population within a matter of weeks, would lead to an aggressive reopening of the economy and could lead to 4.1% GDP growth for the year.
  • A downside scenario that we look at is one in which mutations of the virus require longer and stricter lockdowns that last well into the first half of the year and still impact summer holidays substantially. Thanks to mutations, roll-out of vaccines takes longer due to required adjustments and this delays herd immunity until 2022 or later. In this scenario, GDP growth would drop to just 0.9% for the year.
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