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Our views 04 November 2020

Global economy: an unwelcome third phase of recovery

By Melanie Baker, Senior Economist

5 min read

China’s recovery seems to be powering on, but near-term economic prospects in Europe have darkened and the US faces its own challenges.

The second phase of this recovery after the initial ‘reopening’ phase was always going to be slower, and likely bumpier too. However, second waves of the coronavirus in Europe, and policymaker responses to them, mean that we are entering an unwanted ‘third phase’ of recovery – the setback.

We saw record economic growth in Q3 in the US and Europe, but after record contractions in Q2, these economies were still left smaller than their pre-crisis selves. Meanwhile, Q4 is shaping up to see the level of economic activity fall in Europe as large swathes of the continent re-enter lockdown. 

Business surveys released earlier in October were already somewhat mirroring developments in Covid case numbers. The composite Purchasing Managers’ Index (PMI) business survey measure looked healthier in Australia, solid in China, unchanged in Japan, but worse in the euro area and UK (though the US PMI rose, despite higher Covid numbers). Taken at face value, a euro area PMI of 50 would be consistent with no growth in economic activity in October, even before lockdowns in the likes of France and Germany were underway (although mapping business surveys onto economic growth rates remains somewhat hazardous). In the UK, the pre-lockdown October PMI fell significantly, with survey respondents already commenting on the impact of local lockdowns and tighter restrictions on hospitality. The gauge did, however, remain above the 50 ‘no growth’ level.

Across Europe, prospects for Q4 GDP growth have darkened – that was already the case given the rise in Covid numbers and tighter social distancing measures. The euro area and UK economy now look likely to contract in Q4; cue lots of talk of a ‘double dip’ or a ‘w’-shaped recession. How deep these contractions will be will partly be a function of how long the extra layer of government restrictions will last, and how effective they will be at actually bringing down Covid numbers (and therefore lowering people’s and businesses’ fear levels around both the virus itself and the prospect of further lockdowns). The impact on Q4 GDP, for now, looks set to be much less than in Q2: the lockdowns are, in general, not as strict as in April; activity is already starting from a lower level; the quarter is already part way through; firms are likely to be better prepared this time around; households are likely to be more adept at moving activities online, from clothes shopping to exercise classes. However, for some businesses, this second round of lockdowns may prove the ‘final straw’. With every chance that the lockdowns last longer than the few weeks signalled by policymakers, emerging analyst forecasts of 0-4% contractions in euro area output on the quarter could prove too optimistic.

In the US, surveys at least suggest a steadier recovery (so far). The PMI business survey mentioned above improved in the US. Despite rising virus cases, further lockdowns seem less likely in the US; US states locked down for only a few weeks in the Spring, let alone now.  However, the US faces its own challenges heading this winter, Covid case numbers are on the rise again and the provisions of the CARES Act (including more generous unemployment benefit) have long since rolled off. Savings were built up in aggregate in the early stages of the crisis as fiscal support coincided with a (forced) drop in spending.  However, for some families, any such savings will have been rapidly depleted given that 12.6 million people were still unemployed in September. Consumer confidence remains soft too, suggesting a significant number of households may feel worried enough about the outlook to be unwilling to deplete those savings where they have the option.

Time for another dose of stimulus? The European Central Bank sounds likely to add policy stimulus at their December meeting and more stimulus looks likely from the Bank of England at their meeting on 5 November (likely in the form of more asset purchases – still their marginal policy tool – rather than negative rates just yet). In the US, more fiscal stimulus still looks very likely and could come in the immediate post-election period. However, depending on the final result of the election, the politics may point to 2021 as the more likely date.

The views expressed are the author’s own and do not constitute investment advice.