Europe plunges into a deep recession as COVID-battered economies brace for a second wave

July 31, 2020, 10:33 AM UTC

The euro area economy plunged into an unprecedented slump in the second quarter, putting it in a deep hole from which it may take years to fully recover.

Spain took the biggest hit, shrinking 18.5%, while French and Italian output also dropped by double digits. The 19-member region as a whole saw a 12.1% contraction. The declines in activity reflect the effect of strict quarantines measures on businesses and consumer spending, and a slump in tourism in some countries.

The health crisis was most severe in the region’s least economically resilient members, leaving them with little firepower to support households and businesses. That forced European Union leaders to overcome longstanding differences on joint borrowing and agree an historic €750 billion ($889 billion) rescue fund this month.

National governments have already stretched their budgets to deal with the crisis, and the European Central Bank launched a €1.35 trillion bond emergency program to contain the economic shock.

“I don’t think anybody really realistically should think that levels of GDP by the end of 2021 will be back at the pre-crisis levels,” Erik Nielsen, UniCredit Group chief economist, told Bloomberg TV’s Francine Lacqua and Tom Keene. “Monetary policy will keep the pedal to the metal.”

The euro was trading at $1.1853 as of 11:54 a.m. in Frankfurt, little changed on the day. It had earlier risen above $1.19.

Vulnerable Southern Europe

The ECB’s actions have particularly targeted southern Europe after bond yields in Italy spiked early in the crisis because of investor worries that huge health spending could cripple the the country’s already-weak finances.

While the economy’s second-quarter slump was less than in Spain or France, it’s in a particularly vulnerable position because of its debt burden and sluggish long-term growth.

Overall, the rebound in Europe is under threat from a surge in new outbreaks that’s emerging across the globe. Governments are reluctant to impose strict national lockdowns, but economies could suffer anyway if fear of infection alters consumer behavior, stops people going to stores, bars and restaurants.

That puts countries such as Italy, Spain and Greece—all of which have huge tourism sectors—under the spotlight. Spain’s already bad summer seasontook a turn for the worse last weekend when the U.K. announced that holidaymakers returning from the country would have to quarantine because of an uptick in coronavirus cases in some regions.

The other major risk is long-term damage to the labor market. Government support programs in Europe prevented unemployment from surging as it has in the U.S., but they may only be delaying rather than preventing devastating layoffs.

All eyes on the ECB

With the outlook so uncertain, economists expect the ECB to increase its bond-purchase program again before the end of the year to revive growth and bring inflation closer to its target of just under 2%. Data Friday showed euro-zone consumer prices grew 0.4% in July.

Euro-area unemployment is already slowly creeping higher, and job losses are mounting as companies across the continent respond to weak demand and a dramatically changed global backdrop, particularly for travel and tourism.

Airlines have announced thousands of job cuts, while France’s Airbus SEcould eliminate 11% of its global payroll. Its plans to reduce headcount in Spain — where unemployment is already high — sparked demonstrations earlier this month.

High frequency data and surveys show that activity has so far bounced back from its trough in April and May. The sustainability of that is in question, however, particularly amid growing concern about fresh virus outbreaks.

Germany, where the economy shrank 10% in the second quarter, has already sounded the alarm over rising infection rates.

“We observed a slight recovery in sentiment and certain soft indicators. So we can say in Europe we have the first signs of recovery,” ECB Governing Council member Yannis Stournaras said in a Bloomberg interview this week. “Still, the risks are on the downside.”