Recovery in the Euro Area

About the author:

Michael Knox
Author name:
By Michael Knox
Job title:
Chief Economist and Director of Strategy
Date posted:
10 August 2020, 12:00 PM

Every quarter we present a model of year-on-year growth rates of GDP in the Euro Area.

Our model is based on the Economic Sentiment Indicator published by the European Commission.

The Economic Sentiment Indicator is a very detailed survey. It includes the surveys of both businesses and consumers in five different sectors in each country of the European Union. There is a survey of businesses and consumers in the Manufacturing sector.

There is a survey of business and consumers in the Services Sector. There is an independent consumer survey. There is a survey of businesses and consumers in the Retail Sector and there is a survey of businesses and consumers in the Construction Sector.

This is put together as an overall Economic Sentiment Indicator in each and every individual country of the Euro Area. That then gives us a single index number which we use for modelling the GDP growth of the Euro Area.

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Severe slump

In February, before the shutdown in the Euro Area, that number stood at 103. There was a great amount of strength in the Services sector and also in Construction in the Euro Area.

As we all know, when we got into April there was a severe shutdown.

In the Euro Area, there was a hard slump in the Services sector but also importantly in Manufacturing. There is a lot more manufacturing that is done in the Euro Area as a proportion of the total economy than there is in the US. A lot the components that are used in manufacturing in Germany are made in Italy and Spain.

The slump in activity in the Services and Manufacturing sectors, took the total level of the index down from 103 in February to 63.8 in April, a fall of almost 40%. What happened was an enormous fall in GDP in the Euro Area which was worse than the falls which happened in the United States, or in Australia.

The total level of fall in GDP in the Euro Area between the first and second quarters was a decline of 15%.

That compares to a total fall for GDP in US in the same period of about 10% and a total fall in output in Australia of say 7.3%.

This is very, very severe. When we look at the major economies, we find that the fall was hardest in Spain where there was a dramatic slump.

The next worst affected was Italy, followed by France. The decline in Germany was about half of what happened in Spain, and about two thirds of the decline that happened in Italy. In other economies, particularly the US, the first part of this recovery is very, very rapid.

The US economy looks like getting about half of the total decline of the previous two quarters back in the third quarter. In the US economy for example, the decline of about 10% in the first two quarters in US GDP is being matched by a rise of about 5% in the third quarter.

Rapid recovery

The recovery in the third quarter after the shutdown is extremely rapid. We expect to be seeing something like that in the Euro Area.

We have seen significant recoveries in the Economic Sentiment Indicator for the Manufacturing sector and we have seen significant recoveries in the Indicator for the Retail sector and also significant recoveries in the Indicator for the Services sector.

The economy is bounding back very rapidly in the Euro Area. Our economic sentiment indicator has risen from 63.8 in April to 81.8 in July.

After falling almost 40%, it has recovered half its losses. When we turn that into a model of Euro Area GDP, our model estimate is that after a fall of 15% year-on-year in the year to the second quarter, we get a lot of that back in the September quarter, around half of it back.

The year-on-year decline in output should ease to about 7.3%. That means that in the third quarter we are going to get a recovery in the Euro Area economy of around 7.7% of GDP. That is what the survey tells us is happening here.

There is a much larger proportion of the Euro Area economy that is in manufacturing as in the US. That manufacturing can come back really very rapidly. That is component manufacturing in Spain and Italy for manufacturing in Germany.

Conclusion

What the Euro Area Economic Sentiment Indicator shows is that, in the third quarter, we are having a very rapid recovery in the Manufacturing sector as well as Services sector and the Retail sector. That allows a big initial kick in output growth in the Euro Area, proportionately similar to what is happening in the US.

Still, we think it will take another four or five quarters to get Euro Area output back to where it started in the beginning of this year.

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View more analysis from Michael Knox by clicking on 'economic strategy' in the popular topics list, or listen to his full playlist of podcasts on Soundcloud. Alternatively, contact your Morgans adviser or nearest Morgans branch.

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