Euro area: recovery around the corner
According to Eurostat's flash estimate, euro area GDP fell by 0.6% q-o-q in Q1, after a drop of 0.7% in Q4. This confirms that the euro area is experiencing a limited double-dip recession and leaves GDP 5.5% below its pre-covid level.
Looking ahead, surveys have been encouraging, indicating that the worse is probably behind for the euro area. Manufacturing activity remains strong, although growth is being held back by supply problems. The service sector continues to lag, principally reflecting ongoing social restrictions to combat the pandemic. There has also been good news on the employment front.
Economic momentum will probably accelerate in late Q2/early Q3 as countries progressively reopen. Vaccination campaigns in the euro area have lagged those in the US and the UK, but the pace of vaccination has improved significantly over the past few weeks. This will allow restrictions to be progressively relaxed and hasten the economic normalisation already underway, led by increased consumer spending. Whether international travel restrictions are lifted or not will be important for southern European countries in particular. Economies will also continue to benefit from the strengthening of global growth, helped along by US fiscal stimulus. The launch of Next Generation EUwill also support the recovery even if the boost will probably only be felt from Q4 on.
All in all, we continue to expect a consumer-led rebound in the euro area in late Q2/early Q3. Our central forecast is that euro area GDP will expand by 4.3% in 2021 and 4.5% in 2022, with risks broadly balanced. The pace of vaccinations and policy support remain the key determinants of the euro area’s economic prospects.
We expect HICP headline inflation to average 1.4% in 2021 and 1.2% in 2022 and core inflation to average 0.9% in both 2021 and 2022. Risks to our forecasts are tilted to the upside, mainly due to inflation pressures resulting from supply bottlenecks.
As for the European Central Bank, the battle between hawks and doves is engaged as monetary policy becomes more data dependent. Better economic data could galvanise the hawks on the Governing Council into action. Calls to taper ECB asset purchases within the framework of the Pandemic Emergency Purchase Programme (PEPP) from as soon as Q3 will probably grow louder.