Euro area: Spring is in the air
May brought the first evidence that a recovery is taking shape in the euro area (see Danske growth tracker). Both the service and manufacturing PMIs rebounded – though remaining in contraction territory – as the economies partly started to emerge from lockdowns. Moreover, forward-looking expectations components in a range of leading indicators extended their rebound, signalling that the economy should soon move into the ‘upswing quadrant'. Overall, leading indicators tell us that the downturn has bottomed out, but the level of the PMIs still indicate that economic activity continues falling, only at a slower pace than previously. Hence, it is essential that we see PMIs rebounding above the 50 level in the coming months before we can talk about a real recovery taking shape. We still expect a gradual euro area recovery to unfold in H2 20, led by private consumption and supported by a sizeable fiscal boost, but the risk of an asymmetric recovery between the North and South remains. Germany unveiled another massive recovery stimulus package of EUR130bn (3.8% of GDP) to boost consumer demand and strategic investments, and the fiscal tailwind is one reason why we expect the German economy to weather the COVID-19 storm better than other European countries (see The Big Picture - Reopening, recovery and risks, 2 June 2020).
In contrast to the economic damage, the negative impact on the euro area inflation outlook has been more muted so far. Thanks to a surge in food prices and an upward bias for core inflation, resulting from imputations of services prices, euro area HICP inflation just about avoided falling into sub-zero territory in May (0.06%). We think disinflationary pressures from falling oil prices and discounting campaigns will maintain the upper hand in the near term. However, unprecedented monetary/fiscal easing and cost push inflation in some industries leave room for a reflation spiral eventually to emerge (see also Euro Area Research - The road to recovery, 14 May).
May also marked the beginning of a possible new era for the EU. The EU Commission unveiled the details of an ambitious recovery fund (under the headline ‘Next generation EU') amounting to EUR500bn in grants + EUR250bn in loans (see chart for country allocation and Flash Comment: Next Generation EU: A landmark for European history?, 27 May). We view the recovery fund as an important game changer both on the economic and political fronts. Although it does not resolve the issue of high debt levels, it marks an important step towards solidarity and risk sharing at the European level. We expect the fiscal boost to alleviate the risk of an asymmetric recovery, although most of it will likely only materialise in H1 21.
The arrival of a common European fiscal response is especially welcome, as the ECB's crisis fighting power has lately come under pressure after the ruling of Germany's constitutional court. However, ECB policymakers left no doubt about their commitment to support the euro area recovery and contain financial fragmentation and extended the Pandemic Emergency Purchase Programme (PEPP) at the June meeting by another EUR600bn until June 2021 (see Flash ECB Research: ECB gave markets a PEPP talk, 4 June). Credit growth, especially to corporations, has accelerated in recent months in a sign that the ECB's stimulus is supporting the real economy.
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
