A harsh winter, but outlook brightening

Karsten Junius January 29, 2021 10:35

COVID-related restrictions have been extended and tightened across the euro area in recent months. Restaurants and retailers are largely closed in many countries, with online shopping unable to fully compensate. The manufacturing sector, however, remains strong, driven by the global cycle as well as a strong domestic demand for goods. We expect sentiment in the services sector to jump significantly once restrictions are phased out. Indeed, thanks to government support, household income remains stable and saving rates are high. This should allow for a strong rebound of economic activity once services can resume.

ECB board member Schnabel, however, has already stated in an interview this week that the medium-term outlook for inflation remains muted and that further fiscal policy support is needed. In our view, this rules out a tightening of monetary policy anytime soon.

As an export-oriented economy, Switzerland is benefitting from the strong global demand for goods. With the country’s tourism and hospitality sectors forming a comparatively small part of its GDP, it has seen a more stable GDP development than in other countries. Switzerland has also been enjoying stronger growth than the euro area average as it did not follow its neighbors in shutting down the economy as much – a course that was just reversed this Wednesday as the more contagious COVID-mutation risks spreading further. Starting on Monday, most retailers, restaurants, cultural venues and sports facilities will be closed until the end of February. We expect 3% GDP growth and no change of its monetary policy as inflation remains on average negative again this year.

Meanwhile, lockdowns in the UK have been tightened and extended as new cases have accelerated and hospitals are becoming overwhelmed. As a result, GDP is likely to contract again in the first quarter of the year, which would push the economy into a ‘double -dip’ recession. Disruptions caused by the new border checks on traded goods will hurt activity too. We have therefore revised down our GDP forecast for 2021 to 4.6%, from 6.1% previously. Still, the rapid vaccination campaign should help authorities lift restrictions in the spring, allowing activity to rebound strongly. In the long term, as we explained in a recent in-depth piece, the new trading regime with the EU will have a significant negative impact on the economy.

With the economy not expected to regain its pre-pandemic levels before 2023, underlying inflationary pressures will probably remain muted. In our view, the MPC will have to mark down its growth and inflation outlook when it meets in February. Its November Monetary Policy Report shows GDP expanding by 7% in 2021 and the inflation rate reaching 2% by the end of the year (we see inflation at 1.6%). As a result, we think that more monetary support will be needed this year. We have maintained our long-held view that the policy rate will be cut into negative territory, though the MPC remains deeply divided on this issue and may favour instead to expand its QE programme more aggressively.

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Karsten Junius

Chief Economist, Head Economic Research at Bank J Safra Sarasin