Economic outlook: After 2020’s bitter winter, can an “Indian summer” follow in 2021?

Following the Coronavirus outbreak, the year 2020 has brought some exceptional surprises, widespread public health concerns and previously unthinkable “black swan” events.

With some European countries now in a second lockdown, but prospects of an effective vaccination becoming increasingly positive, Commerzbank Switzerland recently hosted a webcast bringing together economists from the Swiss National Bank (SNB), European Central Bank (ECB) and Commerzbank to discuss the two key questions that we’ve received from our clients: How exactly have lockdowns impacted economic activity and prompted changes in economic and monetary policy across the continent? And what are the projected time horizons for recovery?

While predicting the recovery’s timeline is of course fraught with difficulty, at Commerzbank we remain hopeful for improving conditions from spring 2021 onwards after a difficult winter period. Assuming the widespread availability of vaccinations, coupled with returning investor confidence, it is hoped that our clients will feel the return to pre-crisis conditions sooner than others might have anticipated.

The crisis unfolds

Certainly, our panellists agreed that the crisis has been unlike any other in recent memory – with declines in output far exceeding those seen during the global financial crisis (GFC). According to the ECB, in the eurozone, GDP declined sharply by 11.2% in Q2 2020, while a slight decline in Q1 2020 means that the first-half figure is closer to 15%.

These Corona-related declines preceded a recovery in Q3 2020, but this has not been enough to offset the downturn and return GDP to pre-pandemic levels. Inflation, too, has fallen considerably: core rates in the eurozone have fallen to around 0.3% during the crisis – partly due to lower energy costs and changes to value-added tax (VAT) policies, as seen in Germany.
Regarding sectoral disparities, Commerzbank’s Chief Economist, Dr Joerg Kraemer, noted that the German manufacturing sector seems not to have been hit during the second lockdown. The same cannot be said for the hospitality sector and other Corona-sensitive services sectors, however, which account for about 8% of GDP and for which activity has fallen significantly.
Dispersions in GDP performance have been evident, too, from country to country. GDP in Italy, for instance, has been much harder hit than others – an unsurprising development for one panellist who noted that sectors such as tourism constitute a much larger proportion of GDP in southern Europe.

Banks play a supporting role

Though far more severe than the GFC, the Corona crisis has been an exogenous shock to the global economy and banks have been regarded part of the solution in cushioning the immediate, negative economic impacts. The ECB has helped by pursuing three main policy objectives: supporting liquidity conditions and ensuring a smooth transmission of monetary policy, using fiscal policy to sustain the flow of credit to households and corporates (in particular SMEs) as well as maintaining favourable financing conditions for all sectors. Measures such as the Pandemic Emergency Purchase Programme (PEPP) and targeted longer-term refinancing operations (TLTROs) have indeed offered respite to fragile economies. The SNB has supported the Swiss economy through similar fiscal and monetary measures to plug liquidity gaps through the crisis and by offering loan guarantees that remove a degree of risk from private banks.

The recovery timeline is contested

Perhaps unsurprisingly, subject to most debate was the timeline of the eventual recovery. The SNB acknowledges that the recovery must endure a difficult starting position but, equally, the recovery in the eurozone is already underway as GDP for the bloc has shown signs of normalisation from Q3 2020.

Despite positive news of a vaccination becoming available next year, it still sees considerable downside risks for the Swiss economy. While GDP has similarly increased from Q3 2020, the country’s exports (excluding pharmaceutical and chemical products) flattened as the continent’s second raft of lockdowns came into effect – typifying Switzerland’s exposure to its trading partners as a relatively small and open economy.

Kraemer at Commerzbank sees this timeline quite differently, however. He believes that there is a tough winter ahead during which eurozone economies should be braced for recession. Indeed, Kraemer remarks that during the summer, economists and statisticians had begun to revise their forecasts expecting improved conditions for Q4 2020. But, fast forward to November, and now an opposite trend is emerging as larger economies, such as France, look poised to post negative growth.
For Kraemer, though the economic woes are expected to be more prolonged, there is hope of recovery on the horizon. Of course, milder temperatures from the spring, coupled with the prospect of effective immunisation from mid-2021, should help the eurozone to post strong growth during Q3 and Q4 2021 – enough, in fact, to allow eurozone GDP to return to pre-crisis levels before 2022.

In short, next year could be described as a contrasting year: a tough and bitter winter semester followed by much more benign conditions starting in spring and unfolding towards the end of 2021. Kraemer remarks: “You may call it an ‘Indian summer'.”

Risk of near-term inflationary issues is low

Another point of difference between the economists’ forecast came on the issue of inflationary pressures caused by expansionary monetary policy. While the participants agreed that inflation will inevitably rise following the Corona crisis, Kraemer believes that core inflation will see a minimal normalisation from 0.3% to 0.7% in early 2021 – largely in anticipation of higher unemployment rates. Among some clients, this represents a benign forecast. But Kraemer’s response is that money supply is indeed rising but it is mostly fuelled in the form of sovereign debt being added to budget deficits (and the ECB’s willingness to offer finance). This means that while monetary inflation potential does indeed exist, it is unlikely to convert into an inflationary issue for some time.

Here for our clients come what may

There may yet be further surprises around the corner as, together, we venture through what has been an unprecedented public-health and economic crisis. Nevertheless, through these uncertain times, Commerzbank aims to be a pillar of support for its clients no matter what the recovery period may bring. If you have any questions about our economic research or would like further advice on how we can support your business through the Corona crisis, please do contact your Relationship Manager or local branch.

With thanks to our distinguished panellists:

Dr Petra Gerlach, Head of Monetary Policy Analysis, Swiss National Bank (SNB)

Dr Katrin Assenmacher, Directorate General Monetary Policy, European Central (ECB)

Dr Joerg Kraemer, Chief Economist, Commerzbank AG