The pandemic hit the euro-area countries particularly hard, with many starting to experience a second wave towards the end of 2020. Looking ahead, the recently approved vaccines are laying the ground for the region’s recovery this year – we expect two-thirds of Europe’s population to be vaccinated by late 2021. On the economic front, we expect GDP to grow 4.0% in 2021 and 3.7% in 2022, after falling to -7.7% in 2020.
The real impact of the vaccines is unlikely to be felt until Q2 2021. Supply and logistical issues may delay vaccine rollout, social distancing and travel constraints will likely continue for some time after vaccinations begin, and pent-up demand for services is likely to be limited. Governments are likely to mandate ongoing social distancing until a sizeable number of people have been vaccinated.
Services will be relatively slow to return to normality; the hospitality, entertainment, travel and tourism sectors are expected to operate below capacity at least until mid-2021. By H2 2021, a recovery in spending and investment should boost GDP growth to an annualised pace of around 6%.
The euro area’s current account surplus should narrow with the growth in exports across the world. Additionally, stronger household spending and investment in 2021 will boost imports, further eroding the external surplus.
Policy – staying supportive
The European Central Bank is set to maintain favourable financing conditions, having eased policy in December to tackle near-term economic challenges, extending incentives for banks to lend and continuing the Pandemic Emergency Purchase Programme (PEPP) through to March 2022.
While ongoing fiscal support is likely to be needed at least in H1 2021, the scope may be limited by high levels of indebtedness in some countries. We expect the euro-area fiscal deficit to narrow to 6.0% of GDP in 2021 and 4.5% in 2022 from 9.0% in 2020.
European Union (EU) leaders have agreed in principle on a mutual fiscal support package to finance infrastructure and other spending to help countries rebuild their economies from 2021, but a stalemate on the new EU budget could delay disbursement of recovery funds.
Entering the post-Brexit world
A basic UK-EU free-trade agreement, incorporating zero tariffs and quotas, came into effect on 1 January 2021, avoiding the worst-case scenario of WTO trading rules. But there may still be significant disruptions to trade given the need for new customs and regulatory checks at the border, particularly in the first few months of the year as businesses take time to adapt to new trading procedures.
Outlook for the EUR
A weaker USD, which we expect, along with COVID relief measures should favour the EUR (EUR strength, like CNH strength, is the natural corollary to USD weakness). The services sector across Europe has been hit particularly hard by COVID induced lockdowns and stands to benefit from a vaccine driven COVID normalisation this year. In addition, given the region’s strong links to China via Germany’s manufacturing exports, the potential growth recovery in Asia should benefit the EUR.