Key features of the European Commission’s Winter 2021 interim forecast
Europe remains firmly in the grip of the coronavirus pandemic. The resurgence in the incidence of infection, together with the appearance of new, more contagious variants of the coronavirus, has forced many member states to reintroduce or tighten containment measures. The European economy is thus set to open the year on a weak footing. At the same time, the start of vaccination programmes throughout the EU provides grounds for cautious optimism.
A feeble start to the year for the European economy…
Following a sharp increase in reported infections in mid-November and the spread of new, more infectious variants of the virus, governments were forced to reintroduce containment measures, restrict cross-border movements, or reinstate lockdowns to contain the surge in hospitalisations and a filling up of intensive care units. These interventions have generally been more targeted and less harsh than those imposed in spring 2020. Together with the capacity of households and firms to ‘learn to live’ with the virus, the decline of mobility has also been less steep (Figure 2). The output loss in the EU in the fourth quarter of 2020 was thus relatively benign compared to what we experienced over the first half of 2020. EU real GDP declined by 0.5% with some member states managing to grow, according to Eurostat’s preliminary flash estimates. The softening January survey indicators, however, foretell a feeble start of the economy in 2021.
Figure 1 Cumulative number of COVID-19 cases in the last 14 days
Figure 2 Stringency of restrictions and mobility, EU
Note: Indicators weighted by the sahre of countries in the EU GDP.
Source: Oxford University, Google.
… but spotting light at the end of the tunnel.
While the roll-out of vaccination campaigns makes the road ahead clearer and significantly brighter, the race between injections and infections remains challenging. Acknowledging these uncertainties, the Commission’s winter forecast assumes that containment measures will ease marginally towards the end of the second quarter, and fall markedly, yet not completely, in the second half of the year. It is assumed that containment measures will remain marginal towards the end of 2021 with only targeted sectoral measures still present in 2022.
The pandemic resurgence delays the recovery further into 2021…
These assumptions closely follow the targets of vaccinating at least 80% of people over the age of 80 and 80% of health and social care professionals by end-March, and a minimum of 70% of the adult population by summer 2021.1 As vaccination campaigns gain momentum, the pressure on health systems subsides and restrictions ease, activity is forecast to post a moderate uptick in the second quarter, led by private consumption with additional support from global trade. A large stock of accumulated savings, persistently low inflation, and massive policy support should help spark a strong rebound in the third quarter. Apart from a boost from consumer spending, countries with sizeable tourism sectors are likely to benefit from the acceleration of intra EU touristic traffic over the summer. As uncertainty dissipates, a highly accommodative monetary policy and sustained fiscal support offer further incentives for a step-up in private investment. After the strong rebound in the second half of this year, the economic momentum should moderate in 2022. For this year as a whole, the EU economy is forecast to grow by 3.7% before accelerating slightly to 3.9% in 2022, reaching pre-pandemic output levels in the first half of 2022.
…which will be uneven across Europe.
Just as the pandemic’s initial hit was very uneven across Europe, so will be the member states’ recovery paths. More than half of the member states are forecast to close the distance to their pre-crisis output levels by the end of 2021. Others, however, are expected to take longer. Many factors contribute to such outcome. The economic structure, the share of the tourism sector in particular, and the size of policy responses are among them. Yet, the road out of the crisis still critically depends on the pandemic’s evolution as well as the stringency and duration of measures needed to contain it. The longer the crisis protracts, the greater the risk of large cross-country divergences becoming entrenched, especially if policy responses do not address them adequately.
Figure 3 Real GDP growth path, EU
Note: WiF2020 for 2022 extrapolated from quarterly growth over 2021.
Figure 4 GDP levels compared to 2019 Q4 (in %)
Note: No GDP quarterly forecasts are reported for CY, EL, MT and LU.
How much longer is the tunnel?
To shed light on some of these uncertainties, two alternative model-based scenarios2 accompany the winter forecast.3 In an upside scenario, the advancing vaccination process leads to a faster improvement in the pandemic situation, allowing governments to remove restrictions as early as the second quarter of this year. This could happen if the vaccination roll-out moves more quickly than expected, or hampers virus transmission to a larger extent than we currently think based on preliminary evidence (e.g. ECDC 2021a).
Under these assumptions, confidence among consumers and firms brightens significantly, and together with the reduction in voluntary social distancing, encourages households to reduce accumulated savings to a greater degree. The ensuing surge of pent-up demand helps kick-start the recovery as soon as the second quarter of this year when the economy could bounce back by up to 2 percentage points more than in the baseline. These positive developments extend into the summer season when there should be room for intra-EU tourism to recover faster than envisaged in the central projection. With annual growth exceeding 5% in 2021, the rebound from the crisis is thus faster and more forceful, with GDP returning to its pre-pandemic level before the end of this year (see Figures 5 and 6).
By contrast, a flaring up of infections due to new and more contagious mutations of the coronavirus, a lower efficacy of the vaccines to these mutations, or delays in the roll-out of vaccination programmes, could require tighter containment measures throughout 2021.4 Under these adverse assumptions, spending opportunities remain curtailed for longer, dampening consumer confidence and leading to a further accumulation of savings. With firms also missing out on revenue from the summer tourist season, the ensuing protracted period of sluggish economic activity causes longer-lasting economic damage to our economies.5 These headwinds would likely be felt through a higher number of bankruptcies, a prolonged shortfall in business investment, higher unemployment, and damage to firms’ balance sheets. In this scenario, the recovery is delayed though not derailed. While the economy bounces back at the end of 2021, the rebound is softer than projected in the forecast baseline. Growth would only mildly surpass 2% in 2021 and fail to reach pre-pandemic levels before the end of the forecast horizon.
Figure 5 Index of real GDP, euro area (2019 Q4 = 100)
Note: The pre-pandemic growth path equals the winter interim forecast. 2020 projections up the end of 2021 and extrapolated thereafter.
Figure 6 Annual GDP growth rates, euro area
These two scenarios bring out the importance of vaccinations for the economic trajectory. Beyond the obvious health benefits, effective vaccines and their roll-out could add about three percentage points to annual growth this year compared to a slow roll-out of vaccination or less effective vaccines. Needless to say, a delayed recovery is likely to leave its mark on the fabric of the European economy and society. Given the disproportionate impact of the crisis on women, lower-wage earners (e.g. OECD 2020), and youth, a deepening of pre-existing inequalities is a real risk.
On the upside, following our usual no-policy-change approach, the winter forecast takes account of only a fraction of the recovery measures that could be financed by NextGenerationEU. As the national Recovery and Resilience Plans are gradually implemented, the large-scale financial support for investment and reforms from NextGenerationEU and its centrepiece, the Recovery and Resilience Facility, will fuel6 a stronger recovery than expected in the forecast.
Albonico, A, L Calès, R Cardani, O Croitorov, F Di Dio, F Ferroni, M Giovannini, S Hohberger, B Pataracchia, F Pericoli, P Pfeiffer, R Raciborski, M Ratto, W Roeger and L Vogel (2019), “The Global Multi-Country Model (GM): an Estimated DSGE Model for the Euro Area Countries”, ECFIN Discussion Paper 102.
Bańkowski et al. (2021), “The macroeconomic impact of the Next Generation EU instrument on the euro area”, ECB Occasional Paper 255.
European Central Bank (2020), “Eurosystem staff macroeconomic projections for the euro area”, Technical Report, December.
ECDC – European Centre for Disease Prevention and Control (2020), COVID-19 vaccination and prioritisation strategies in the EU/EEA, December.
ECDC (2021a), Infection prevention and control and preparedness for COVID-19 in healthcare settings – sixth update, Technical Report, February.
ECDC (2021b), Integrated COVID-19 response in the vaccination era, Technical Report, February.
European Commission (DG ECFIN) (2020), European Economic Forecast Autumn 2020, European Economy Institutional Paper 136.
OECD (2020), OECD Economic Outlook, Volume 2020 Issue 2.
International Monetary Fund (2021), World Economic Outlook Update, January.
1 The Commission communication of 19 January 2021 (see https://ec.europa.eu/commission/presscorner/detail/en/IP_21_143).
2 See also scenarios presented in IMF (2021) and ECB (2020).
3 The analysis uses the Commission’s structural Global Multi-Country Model (GM), developed jointly by DG ECFIN and the Joint Research Centre of the European Commission. For a detailed description, see Albonico et al. (2019).
4 See the analysis of the European Centre for Disease Prevention and Control (ECDC 2021b) and the arguments therein.
5 Exemplified in the model simulations by tightening financial conditions.
6 See also the Commission analysis in Special Issue 3.2 “Macroeconomic Effects of NextGenerationEU” in European Commission (2020: 65-70) and Bańkowski et al. (2021).