A Light at the End of the Tunnel for European Economic Recovery

A Light at the End of the Tunnel for European Economic Recovery

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After being thrust into a sudden recession in 2020, the European economy is looking toward the second half of 2021 for a recovery to be in full swing. That is when Europe in particular is expected to reach herd immunity from the pandemic, which is widely expected to lead to the lockdown restrictions being eased across the eurozone. Indeed, that is when many countries expect to begin moving away from economic contraction and toward expansion once again. In the interim, 2021 could still be slow going, with the expectations set for the European economy to shrink by 7% this year. 

And while forecasts are a difficult bet to be making at the moment, given the uncertainty of the virus, things appear to be looking up. In fact, according to European Economic Commissioner Paolo Gentiloni, 2021 is off to an “incredible start,” thanks in large part to the start to the rollout of the vaccines. The problem, he adds, is that while there is a light at the end of the tunnel, “we don’t know how long the tunnel is.” Swedbank, meanwhile, calls it a “flickering” light at the end of the tunnel.

Indeed, uncertainty continues to loom as restrictions and travel bans are reinstated. And while economic recovery is expected, it will likely be uneven in nature across European countries as well as various sectors of the economy. Manufacturing, for instance, is rebounding nicely, while consumer-focused services businesses continue to struggle.

In Sweden, for instance, services businesses aren’t expected to receive financial relief until the middle of February, with payroll support potentially delayed until April 2021. This threatens to trigger a wave of bankruptcies that could stall the economic recovery in the country.

Meanwhile, the 2008 financial crisis isn’t too far in the rearview mirror, and Europeans recall that the economy took longer to bounce back than it did for the United States. This time around, however, things could be different.

For instance, the European Commission sentiment indicator inched higher at year-end 2020 to a reading of 90.4 in December from 87.7 in November. The upbeat mood was fueled by a positive vibe from consumers and the industrial sector. Italy and Spain saw sentiment improve, while the service providers and retailers suffered declines. Retail sales suffered a 6.1% drop in November, which was the worst performance since April 2020. Morgan Stanley analysts forecast that the European economic recovery will be three-times faster than it was after the financial crisis of 2008.

For 2022, the International Monetary Fund is predicting that Europe’s economy will expand by 4.7%, which can’t come too soon for businesses and households alike. The IMF points to mass vaccinations from COVID-19, the relaxation of travel bans and economic stimulus as the catalysts for the recovery. And while the rebound may take time, it is expected to show significant progress in the second quarter of 2021, as green shoots of recovery begin to emerge.

Baltics Overview

For all intents and purposes, the Baltic states have fared quite well throughout the pandemic. Similar to much of the Euro area, however, the Baltics aren’t expected to feel the economic tailwinds until the second half of 2021, as per Swedbank.

While Latvia, Estonia and Lithuania weathered the crisis quite well in 2020, a second wave of the pandemic has thrown a wrench into the recovery. And like broader Europe, the region is still subject to lockdown measures, which slows down economic growth. Lithuania in particular implemented some of the harshest restrictions in the region of late.

Nonetheless, domestic demand remains intact and exports are on the rise in the region. The hardest-hit sector appears to be hospitality, which isn’t surprising given the travel bans in place around the world. Overall, the economy of the Baltics is on the right track, with GDP expected to expand by more than 4% in 2022. In fact, the economies of all three Baltic states are poised to reclaim pre-COVID levels in the second half of this year, fueled in part by EU financial support. One of the threats to this recovery is if enough of the Baltics’ population shuns the vaccine.

The Baltics suffered a 2-3 percentage point increase in the unemployment rate in 2020. Conditions could get worse before they get better as a result of the lockdowns, with the services sectors getting hit the hardest for the short-term. Over the medium term, however, the outlook begins to improve, as the stars are expected to begin to align to bolster economic output and the employment picture, particularly as 2022 approaches.

Resilient Housing

Some of the most resilient sectors of the economy have been “financial services, forestry, agriculture, and even most manufacturing sectors,” Swedbank states. Confidence among households remained high as the government’s stimulus measures helped to stem the unemployment situation in the region. In addition, Swedbank points out that many of the unemployed in the region are of the younger generations, the lion’s share of whom are not yet homeowners.

The Baltic housing sector has been another bright spot. Unlike the financial crisis of 2008, the housing market in the Baltics region started on solid footing before the latest crisis hit. While real estate deals in the Baltics took a dive in Q2 2020, particularly in Tallinn and Riga where the number of transactions fell by 33%, the downturn didn’t last and real estate prices held steady and have begun to tick upward in certain markets.

Apartment prices have been on the rise in Baltic capital cities, though in Riga, where many of the apartments were built during the Soviet era, prices have been relatively flat. In the Estonian capital of Tallinn, apartment prices are rising at a rate of about 5%, while Vilnius, Lithuania’s capital, which just turned 698 years old, is seeing a robust increase of more than 10% in apartment prices.

The housing market outlook for the Baltics is a mixed bag. Tallinn and Riga, for instance, are poised to see the current housing price trends persist. Vilnius, meanwhile, could experience an easing in prices in the short-term but for the longer term, the market will benefit from income levels and demographics. Estonia’s housing market, meanwhile, could be strengthened by pension reform that is planned for the third quarter of 2021 — should the eligible population direct their retirement savings into real estate investments. Mortgage rates in the region are expected to stay low this year.

Latvia

Latvia’s economy ended 2020 on a high note, not least because of the UK’s move to bolster its wood supply from the Baltic nation ahead of Brexit. Now, however, it is up to the Latvian government to intervene and keep the economy from taking a step backward in 2021. That is because the second wave of the pandemic has hit the country harder than the first wave, which has led to more restrictions and thus created more of a challenge for economic recovery.

Overall, however, the good has outweighed the bad, and Latvia’s economy is still projected to grow by 2.8% in 2021. If the vaccine rollout goes as planned, then Latvia is positioned to see economic expansion during the summer months, which will be fueled by demand in the pipeline, better sentiment, and higher investments. By 2022, the economy is projected to grow by 5%.

While the Latvian economy is experiencing deflation, a shift is expected in which prices begin to increase by 1.5%. This trend will be fueled in part by rising oil prices in Q2 2021. Additional, declining housing costs are expected to reverse course this year, while food prices will likely continue higher. Swedbank predicts that inflation in the Latvian economy will jump to 3% next year amid a strengthening economy.

Anecdotally, German chain Lidl has opened a major logistics center in Riga that is designed to support the Baltics region. It will be a distribution center of sorts that will deliver goods and services to retail stores in the area. Lidl has already introduced 1,200 to Latvia, and consumers are seemingly looking forward to shopping at the retail locations once they are open to take advantage of the “stack it high, sell it cheap” model.

Estonia

Estonia was an example of what to do right during the economic downturn of 2020, having come through the pandemic stronger than expected and better than many of its eurozone peers. One of the things that stands out about Estonia was its resilience, as the economy was able to bounce back faster than expected, with the exception of some of the most vulnerable sectors like travel.

On average, the salaries of Estonians didn’t take a hit,  and incomes are expected to move higher in the coming years. Swedbank is predicting a 3.5% increase in wages in 2021 followed by a further increase in 2022. The expectation, according to the Bank of Estonia, is for the unemployment rate to increase in the first half of this year. Employment growth is expected to inch higher in 2022.

Once people become vaccinated and restrictions are eased, the economy is expected to be on the road to recovery. Indeed, sentiment will play a role in the recovery, and as consumers become more confident they are expected to spend more once again. While the Estonian economy shrunk by 2.5% last year, it’s expected to expand by 2.9% this year, according to the Bank of Estonia. Swedbank is looking for a more robust 3.1% economic expansion in 2021 followed by a 4.3% increase in GDP in 2022.

Lithuania

Lithuania’s economy could be summed up in a word — resilient. Despite a surge in the number of COVID cases in the country at year-end 2020, and renewed restrictions, locals spent money like champions during the holidays, sending retail trade to record highs, Swedbank reports. Consumer confidence is even moving higher.

The trend among consumers is that household bank deposits have been on the rise, advancing by 18% last year. This suggests that there will be pent-up demand for housing and consumption, which will return to the economy when there is the “all clear.”

Meanwhile, according to the Baltic News Service, Lithuania’s economy is projected to have shrunk less than 2% in 2020, representing the smallest drop in the euro area. Other estimates suggest that Lithuania’s economy declined by about 2.2% in 2020, which compared to the UK’s 11.3% decline is a drop in the bucket.

On an anecdotal note, Lithuania is also attracting businesses from outside the eurozone. London-based fintech Yapily plans to set up shop in Lithuania. The startup joins the likes of other fintechs, including Revolut, Curve and payments platform Square. Yapily’s third European office will be based in Vilnius.

The UK’s Double-Edged Sword

The UK economy is grappling with the one-two punch of a second wave of the pandemic and Brexit. Now that it is no longer a part of the EU, London’s prominence as the leading financial center in Europe is in question. Consumer confidence is on the decline in the region, as retail businesses have been forced to close their doors once again as a result of the renewed restrictions. While consumers are worried about the state of the economy, they feel good about their own personal finances for the next year.

Workers have been fleeing the UK in spades, as companies and foreign-born entrepreneurs alike leave for greater certainty elsewhere. Once the UK’s trade agreements with EU countries are in place, greater clarity should help to offset the damage caused by the separation.

The UK’s economy has been the hardest-hit in the G-7, as the region braces for its worst economic slowdown in some three centuries. The UK’s economy has been especially vulnerable during the lockdowns given its extreme dependence on consumer spending in sectors like restaurants and hotels, which has been on the decline during the pandemic.

Worse is that Great Britain’s economy was already under stress as a result of the prolonged Brexit negotiations, as businesses and households alike tightened their belts. The UK is facing an unemployment rate of 7.3%, or 2.5 million people, in Q2 2021. According to the Confederation of British Industry, the UK’s economy isn’t expected to return to pre-pandemic levels until year-end 2022.

Germany’s Bumpy Ride

Sentiment is low among German businesses as a result of the second wave of the pandemic. The IFO’s business climate index dropped to a reading of 90.1 in January from 92.2 in December. Germany is in another major lockdown until the middle of February in an attempt to thwart the spread of the virus. Germany’s vaccination process has gotten off to a rocky start.

So it is a bumpy start to the year for the German economy, which probably won’t revisit pre-pandemic status until the middle of 2022.  The good news is that thanks to a strong manufacturing sector, Germany is likely to avoid a double-dip recession. That is because factories were better positioned to adapt to the social distancing restrictions vs. retail businesses, which require interaction with customers.

Sweden’s Roller Coaster Ride

Sweden’s economy has been on a roller coaster ride. With vaccinations underway, the country is looking to the spring of 2021 for its economic recovery to get underway. After an expected 3% decline in GDP for 2020, Sweden is expecting an economic expansion of 3% in 2021, according to Swedbank. This is largely dependent on the continued rollout of the vaccines and the expectation that the virus will lose its strength as the warmer spring months near.

Where Sweden is struggling is in its unemployment situation, which has been on the rise and could take as long as several years to undo. Unemployment in the country is expected to decline to below 8% by year-end 2022.

Sweden is already in a zero-interest rate economy but Swedbank says the government will need to step up its game in order to help slash unemployment and help the country face other challenges such as changes in demographics. Swedbank predicts that Sweden’s GDP will return to pre-pandemic status in the second half of this year.

Road to Recovery

The European economy may not be completely out of the woods yet. It is a mixed bag with countries at different stages of their respective rebounds. With sentiment on the rise,  economic indicators showing signs of improvement, and government stimulus funds still flowing, however, 2021 is looking up, especially toward the second half of the year. And if Morgan Stanley’s hunches are right, it will be a much swifter recovery than what Europe experienced during the financial crisis of 2008.

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