Euro area macro monitor: Double-dip recession, but spring is in the air

Euro area GDP declined by 0.6% q/q in Q1 21 and corona-induced consumption weakness and less tailwind from exports were likely the primary drivers of the contraction. Notable country differences were visible, with the French economy expanding by 0.4% q/q due to strong investment performance, while Germany posted a significant contraction of -1.7% q/q on the back of more pervasive service sector restrictions. Furthermore, German manufacturing activity and exports were hit by Brexit repercussions and – more importantly – bottlenecks in global supply chains that led to a shortage of inputs and production stops f. ex. in the important car industry.

Although the Q1 GDP decline has plunged the euro area now formally back into a technical recession, we expect it to be a short-lived one. As virus numbers slowly decline and the vaccination pace picks up, we still think a gradual reopening of the services sector will be possible in Q2, allowing private consumption to play a bigger role as a growth driver again. Further, the Q1 dichotomy between upbeat business expectations and strong order books on the one hand and weak ‘hard’ production data, on the other hand, leaves room for manufacturing and exports to surprise on the upside, once supply chain bottlenecks start to abate. Overall, we forecast euro area growth at 4.3% in 2021 and 4.1% in 2022.

With the end of April deadline approaching, more European countries submitted their recovery and resilience plans to the European Commission to access funds from the ‘Next Generation EU’ instrument. Italian PM Draghi presented an ambitious overhaul plan of the Italian economy worth EUR 235bn (14% of GDP stretched over six years) that also foresees crucial structural reforms in the legal system and public administration. France and Germany’s recovery plans (EUR 41bn and EUR 28bn, respectively) focussed similarly on green investments and digitalisation, but structural reforms played a smaller role.

The April ECB meeting brought no new policy signals, postponing most decisions for the June meeting. ECB still saw the near-term growth outlook 'tilted to the downside'. However, the medium-term growth risk are now seen as 'broadly balanced', which could pave the way for a lower PEPP purchase volume to be agreed at the June meeting in our view (see also Flash: ECB Review - Not a 'significant' meeting, 22 April). Headline inflation continued to increase to 1.6% in April, but with transitory and base effects still in the driving seat and weak underlying inflation pressures in the services sector, ECB continues to look through the near-term inflation spike.

We have taken a deep dive into German politics ahead of the federal election on 26 September. Most importantly, The Green Party is likely to be king-makers in any future governing coalition, opening up the potential for a more relaxed fiscal stance down the line. However, the debt brake will still limit expansionary fiscal policies and a European leadership vacuum leaves room for more political uncertainty on the European stage. For more details see Research Germany: End of the "era Merkel" leaves German politics in unchartered territory, 27 April.

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