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Euro zone rebounds from recession but clouds gather

FRANKFURT (Reuters) - Europe appears to have weathered a pandemic-induced recession better than many feared, a slew of indicators suggested on Tuesday, but prospects for a second wave of infections and a hard Brexit are once again raising talk of more stimulus.

FILE PHOTO: People are seen in a supermarket after the re-opening of the borders, amid the coronavirus disease (COVID-19) outbreak, at the Rhein Center shopping mall in Weil am Rhein, Germany June 15, 2020. REUTERS/Arnd Wiegmann

Having shrunk by over a tenth last quarter, the euro zone economy is quickly regaining strength on the back of relatively resilient consumption, supported by job subsidy schemes, tax cuts and lavish stimulus from the European Central Bank.

Indeed, consumer confidence in the 19 countries sharing the euro rose to -13.9 this month from -14.7 in August, the European Commission said, a reading below its long-term trend but easily beating market expectations.

Adding to the positive news, the Ifo Institute upgraded its forecast for Germany, expecting GDP in the euro zone’s biggest economy to shrink 5.2% this year, a big improvement on its last projection for a 6.7% drop or the Bundesbank’s 7.1% forecast.

The figures suggest that unprecedented fiscal and monetary support have insulated the bloc from an unprecedented recession and households began to spend once again as most restrictions were lifted during the summer months.

Unemployment in the region has barely risen compared to some other major economies and, at 7.9%, has still not moved far from the more than 10-year low of 7.2% hit earlier this year.

Germany’s HDE retail association now expects nominal sales to grow by 1.5% this year, a sharp upward revision from its previous estimate for a 4% drop, helped by a surge in online sales and stimulus measures that have included a temporary VAT cut and cash handouts for parents.

UNSUSTAINABLE?

But the good news may be unsustainable.

Investors are growing increasingly worried about surging coronavirus infections in countries like France and Spain, increasing the risk of lockdowns, a factor not captured by Tuesday’s indicators.

“We doubt this (confidence rise) will be sustained,” Melanie Debono at Capital Economic said in a note. “Further restrictions are being imposed and look set to cause consumer confidence, and perhaps household spending, to drop back in the fourth quarter.”

Worries over a hard Brexit merely compound the troubles and European stocks tumbled this week as markets are now pricing a more protracted recovery with more frequent interruptions.

Indeed, many euro zone countries have reintroduced travel restrictions, forcing airlines to scale back passenger services after a relatively quick run up over the summer.

But most governments appear keen to avoid the type of hard lockdowns seen in early spring and instead opt for localised, targeted measures that allow people to maintain ordinary activities as much as possible.

Mortality is also not following the surge in infections, supporting government efforts to limit disruptions.

Still, the outlook is sufficiently murky for the ECB to make the clearest case yet for even more stimulus, perhaps as soon as the fourth quarter.

“Faced with such a sizeable downward skew (in risks), there is a strong case for our reaction function to be asymmetric, as the risks of a policy overreaction are much smaller than the risks of policy being too slow or too shy to react and the worst-case scenarios materialising,” ECB board member Fabio Panetta said.

He added that while the ECB has done a lot, the inflation outlook is not yet satisfactory as price growth is “uncomfortably” below the ECB’s aim of close to 2%.

“If we encounter shocks that compress demand and pose additional threats to price stability, our reaction function is clearly spelled out: a policy response is necessary and forthcoming,” he said.

Additional reporting by Michael Nienaber; Editing by Andrew Cawthorne

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