Record fall in eurozone growth pushes Italy back 30 years
THE eurozone economy suffered a record-smashing collapse in the second quarter as strict Covid-19 lockdowns and a late start to the summer holiday season set the region back years.
GDP plunged 12pc in the second quarter compared with the previous three months, with the fragile economies in southern Europe hardest hit, Eurostat revealed.
After the woeful second quarter figures, economists warned the recovery could be derailed by signs of a resurgence in virus infections.
Spain and Portugal were the worst hit as summer hotspots bear the brunt of the crisis, shrinking by 19pc and
14pc, respectively.
Germany and France also saw huge contractions of more than 10pc while the Italian economy retreated to its size in the early Nineties.
Overall eurozone output was set back to levels last seen in 2005.
The sharpest fall on record for the bloc in the second quarter follows a 3.6pc plunge in GDP in the first three months of 2020 as restrictions started to be introduced.
After imposing some of the most stringent lockdowns in the world, there are fears that a second wave of infections is brewing in Europe. The UK Government is already imposing quarantine on arrivals from Spain, but more European countries could follow as cases spike.
Rosie Colthorpe, European economist at Oxford Economics, warned “recent flare-ups of the virus in several countries risk derailing this recovery”.
Despite the third quarter pick-up, she said eurozone GDP will only return to pre-virus levels by mid-2022. “While GDP has already started to climb thanks to reopenings, a V-shaped recovery is wishful thinking,” added Bert Colijn, ING eurozone economist.
The eurozone economy was already struggling before Covid as trade tensions and slowing global growth weighed heavily on its big exporters.
Despite the huge falls in output, eurozone inflation edged higher for a second straight month to 0.4pc year-on-year in July, up from 0.3pc in June, according to Eurostat. Sliding energy prices continued to weigh heavily on inflation.
The economic collapse in Spain and France over the last quarter was a massacre. Italy’s GDP fell back to levels last seen in the early Nineties. The picture emerging on both sides of the Atlantic from official GDP data is as traumatic as feared, but it is also in one sense a statistical mirage. An induced economic coma for three months is akin to an extended holiday.
It is not the end of the world as long as the tissue of the economy is kept whole and lost output is fully buffered by fiscal transfers, and so long as support is continued until a V-shaped recovery takes hold – and whittles down the extra debt load.
But this is not what is happening. The pandemic is still wreaking havoc and stimulus is running out before the rebound reaches self-sustaining “escape velocity”. Cliff edges are approaching: furlough payments for workers are being cut; and loan guarantees for firms will expire, as will moratoria on corporate layoffs.
“We’re going to hit a crunch in September and October,” said David Owen from Jefferies.
“Small firms are burning through their working capital very quickly and I’m afraid banks are going to cut their credit lines. There could be a double-dip recession.”
Bernard Connolly, a veteran adviser to central banks, says Western governments risk making the “most catastrophic error of economic policy” since the early Thirties.
The withdrawal of stimulus before the job is done threatens to induce a textbook “Keynesian” recession that “could easily become a depression, one that could destroy the social, political and financial order”.
Eurozone GDP shrank by 12.1pc in the second quarter, taking the loss this year to 15pc. This figure masks a perilous asymmetry for Europe’s monetary union, likely to get worse as the south is left further behind over the next three years.
There were already signs of a eurozone relapse in July. The latest €-coin gauge of “real-time activity” deteriorated further to minus 0.50, from minus 0.35 in June. The index is designed to filter out noise and capture underlying moves in GDP.
Spain’s economy contracted by 18.5pc after the most draconian lockdown in Europe. Weeks later it is battling the pandemic again.
Fresh outbreaks in Catalonia, the Basque region and Zaragoza have led to partial quarantines and dashed hopes for a full-throttle rebound. The rush to save the tourist season may have backfired.
The country’s job support scheme and the firing ban will expire at the end of September. Latent unemployment will then become real.
Citigroup expects the jobless rate to reach 19pc by early next year. Youth unemployment is already 41pc and may again reach the levels of social devastation seen in the debt crisis.
Madrid is mulling plans for a rise in VAT on staples such as fruit, bread and milk in what amounts to pro-cyclical fiscal tightening, a remarkable political twist for a coalition that includes the hard-left Podemos movement, which was born out of the fight against austerity.
France went into recession in late 2019 and has since seen output fall by a fifth. It seemed to be recovering over the early summer but Jefferies’ “activity radar” index shows that web traffic is slipping again for hotels, car dealers, property and ecommerce.
The UK is winding down its furlough scheme, prompting warnings from the National Institute of Economic and Social Research that this could drive unemployment to 3m by the end of the year.
There are 9.7m workers on furlough in the UK and a further 2.7m on the self-employed scheme. A third say they never expect to get their job back again. The furlough figures are 10.6m in Germany, 12m in France and 8.1m in Italy, where the firing ban will end in mid-august unless extended.
While the spigot is being turned off at different speeds in different countries, the overall effect is a flood of people hitting a jobs market still too weak to absorb them.
Renault has announced 15,000 job cuts, BMW 6,000, VW a further 7,000 and Daimler another 10,000. Some 15,000 jobs are going at both Airbus and at Siemens. The cascade of redundancy plans is daily news in the European media. It may cause households to hold on to their lockdown savings as a safety buffer, rather than going on a spending spree. Small companies without access to the capital markets are in most danger, and heavily concentrated in tourism and the Club Med bloc.
The European Investment Bank estimates EU company revenue collapsed by as much as €3.4 trillion (£3 trillion) over the last three months.
Small firms are surviving on lifelines from lenders but a net 23pc of banks say they plan to toughen the terms this quarter. “The sudden tightening compares to late 2007 and has already surpassed the sovereign debt crisis levels. It poses the risk of a credit crunch,” said Katharina Koenz from Oxford Economics.
Defaults almost stopped during the pandemic but that is because the day of reckoning was deferred by state loan guarantees. These expire over the autumn, compounding the coming fiscal cliff with an insolvency cliff.
The EU’S Solvency Support Instrument was supposed to cushion the shock, seeding a €300bn fund to help recapitalise companies drowning in debts. The commission estimates the total need for capital injections could reach €1.2 trillion.
But the fund was scrapped in the bizarre horse-trading of the last EU summit, where spending for science and technology was also slashed to find enough money for the Recovery Fund, the political imperative of the moment. However, the Recovery Fund will not be ready until mid-2021 and thus does not address the immediate danger of economic metastasis and a recessionary chain reaction.
A parallel drama is under way in the US, where GDP contracted by 9.5pc in the second quarter and recovery has stalled as the pandemic “red zone” engulfs 21 states. Two thirds of the lost jobs have yet to come back and the household pulse survey suggests that the labour market is buckling for a second time. Relief payments of $600 (£458) a week to 30m people unable to work have expired but Republicans and Democrats have yet to agree on a fresh stimulus package. States and localities need a $1 trillion infusion of federal money to avert layoffs and an austerity squeeze. The final plan is likely to be too small to fully offset the contractionary mechanics of a declining fiscal impulse.
Buoyant equity markets have lulled leaders in Europe and America into a false sense of security. This is what happened during the stock market rally in 1930, in 1937 and again in 1981. On each occasion the authorities pulled the rug away too soon.
Ample liquidity is not the same as fundamental solvency.
‘The Recovery Fund will not be ready until mid-2021 and thus does not address the immediate danger’