Coronavirus: Scenarios for Europe

With the worsening spread of the coronavirus, governments are rightly imposing ever tighter restrictions on economic activity in ever more European countries.

The extreme uncertainty about the medical outlook and, to a lesser extent, the sell-off in equity markets exacerbate the big fall in confidence.

Against this backdrop, the improving news out of China where the number of active COVID-19 cases has fallen by more than two-thirds from its peak of 58,000 on February 18th to 15,000 on March 12, 2020 is no consolation.

The domestic disruptions in Europe are severely affecting many services industries — even more so than the manufacturing sector. This impact overshadows the likely easing of original supply-chain related disruptions linked to China.

Tough months ahead

As European citizens and governments take steps to slow the spread of the virus, including a partial shutdown of the whole of Italy, retail and services activity is tanking badly even as spending rises in some sub-sectors such as healthcare and supermarkets.

Global demand for, and the supply of, manufactured goods will likely slump through the entire spring 2020 period as the pandemic-related disruptions take a toll on major parts of the global economy.

This will badly hurt trade-orientated Europe. Other countries may have to follow the Italian lockdown, at least to some extent, with a lag of a week or two weeks. This will take a heavy near-term toll on economic activity.

Base case: The worst is over by June

One can expect a broad-based sharp decline in economic output in March which will likely worsen in April and May as authorities take ever more restrictive steps to contain the spread of COVID-19.

The recovery could begin in June as the spread of the virus slows down and a surge in government spending enables health systems to cope better than before.

But even with a rebound in the second half of 2020, annual GDP for the year as a whole would decline by 1% in the Eurozone.

Bad case: The worst is over only by the end of 2020

It is also possible that we will see a further spread of the virus. Severe restrictions on normal activities would then prolong the recession through the second half of 2020 before a rebound starts in early 2021.

That scenario would entail a 3.5% contraction in 2020 GDP in the Eurozone. The rebound would carry on with above-trend gains in GDP from a still low level in 2022. Ultimately, however, the impact of COVID-19 will be temporary.

Increasingly, policymakers are showing that they are ready to do what it takes to avoid a 2008/09-style scenario. The bigger the near-term hit, the stronger the rebound thereafter from a very low level.

Conclusion

Unfortunately, even the huge monetary, fiscal and regulatory policy response on the way across the western world is no obvious circuit breaker in a medical emergency. We need more clarity about the course of the pandemic first.