Central Banks

Euro area: it’s never easy


Big differences in the pace of recovery between countries could pose a threat to the euro area. The ECB is helping, but some burden sharing is needed.

According to preliminary estimates, euro area GDP fell 3.8% quarter-on-quarter (q-o-q) in Q1. This was the worst GDP figure on record—the previous low was -3.2% q-o-q in Q1 2009.


We knew Q1 was going to be bad, but Q2 will likely look worse. Most economies remained in strict lockdown throughout April, with economic activity resuming only very gradually in May. Some sectors, mainly in services, will continue to be disrupted for some time to come. Summer tourism, particularly important for southern Europe, will likely suffer severely from continued covid-19 restrictions.


Our central scenario is for a deep euro area recession in H1 followed by a very gradual and modest recovery starting in Q3, bringing euro area GDP growth for 2020 as a whole to -9.5% before a rebound to +4.5% in 2021. A v-shaped recovery is unlikely in the euro area. Instead, we are likely to see a more gradual, asymmetric u-shaped one. The extent of the health crisis and the structure of their economies mean peripheral countries will suffer the most, notably Italy and Spain.


Most of the burden for dealing with the economic shock has been left to national policymakers, whose response has been uneven. Given their high public indebtedness, peripheral countries in particular are facing a difficult trade-off between near-term fiscal boosts and debt sustainability concerns.


Although to different degrees, covid-19 is a symmetric shock that has hit all European countries at more or less the same time. But the risk is that we end up with an asymmetric recovery. A big divergence in the pace of recovery between countries could pose a threat to the euro area. A strong and credible EU policy response is still lacking. What has been announced up to now is far from enough, in our view. Some burden sharing is needed, but there is strong disagreement on this issue between EU countries.


For the moment, the ECB really remains the only game in town. This week’s German constitutional court ruling could marginally dent the ECB’s ability to avoid financial fragmentation and support the recovery. But it could also increase the pressure on EU leaders to find common ground for a strong and credible EU policy response. In the end, the survival of the euro area will be a question of political will. 


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