Eurozone’s great reopening to unleash pent-up demand

The eurozone is emerging from its second recession since the start of the pandemic as businesses slowly reopen. Restrictions on contact services that limit or prohibit certain activities remain, but the slow return to some normality is welcomed by all.

The European Championship football tournament is a great example of this. Delayed from last year, the tournament has been able to take place across the continent, though only with strict testing and isolation regimes, and a limited number of live spectators allowed for each game.

This has only been possible with thanks to the tremendous acceleration in vaccination efforts. The big four eurozone member states overtook the UK and US in terms of the number of daily vaccinations in late May, and have since managed to close the gap with respect to the share of the population that have been either fully or partially vaccinated (chart 1).

Spain, Italy and Germany now have more than half of their populations fully vaccinated, with France lagging a little behind at about 45%.


In general, confirmed coronavirus cases are significantly lower than where they were at the start of the year. Vaccinations and lockdowns have clearly been effective.

However, concerns remain over the so-called Delta variant, which has caused another spike up in the UK and Spain. The new variant has yet to really take hold in mainland Europe in any great numbers, but if it does, then it is likely to spread far faster than its current prevalent form.

The good news is that evidence from the UK so far suggests that current vaccines are still very effective against the Delta variant. The number of daily new confirmed cases peaked at 47,695 (using a 7-day moving average) on 21 July, and have fallen by 31% since.

Interestingly though, hospitalisations due to Covid-19 were just over a quarter of the level seen at the start of January this year, which is the comparable period when looking at the level of cases. Moreover, deaths were about 13 times higher than they have been recently, highlighting the success of the vaccines programme, even against the new variant which has become the dominant strain. 

It is still too soon to claim victory against the virus, especially as the UK only recently lifted all legal restrictions. It may yet be another week or two before we would expect to see another rise in cases.

But, the evidence so far has been promising, and it should encourage countries with high vaccination rates to continue to lift restrictions. It may even be possible to allow more travel than previously thought, which would be incredibly helpful for the tourism industry, and those countries in the south of Europe that benefit most from visitors.

Decade high recovery

Given the precipitous fall in activity last year, we always expected a sharp rebound once restrictions were lifted. Despite only a partial unlocking, activity indicators, such as the macro composite purchasing managers indices (PMIs) have soared (chart 3).

The aggregate eurozone PMI is at its highest level since February 2000.

Chart_3.jpgStrong domestic and especially rampant export orders have helped lift output, but firms are reporting supply constraints and a growing backlog of unfulfilled orders.

Inventories are also low, and with input prices rising, companies have been forced to raise their own prices to ration demand.

Recently, the services sub-indices have shown most promise. Services firms have lagged behind manufacturing and production firms in recent months, as the former were restricted mainly due to the contact required with customers to operate.

Hesitancy and concerns over the virus will mean that it will take time for demand to return back to normal levels, but it’s worth mentioning that unlike demand for goods, pent-up demand for services is likely to be fleeting.

Yes, that first hair-cut after several months will feel like luxury, but subsequent demand will follow a regular pattern.

Pent up-demand and excess savings

One of the most interesting developments from the pandemic for the economy is the rise in households’ savings rates, and what that means for the outlook for consumption. Household consumption is the largest component of GDP for most developed economies, and so the prospects for spending is critical.

Eurozone unemployment remains low by historic standards, especially when compared to past recessions, and the fall in output. Of course, this was only possible thanks to the active labour market policies that supported households, including short-hour working, also known as furlough schemes.

Rather than making staff redundant to cut costs, companies were able furlough staff on a part-time or full-time basis, with the majority of the costs picked up by government schemes. This helped keep workers attached to their jobs, and reduced the deflationary drag we see from rising unemployment.

It also meant that households were able to maintain reasonably high, albeit lower than normal incomes. Nominal disposable income growth fell from 2.9% year-on-year in 2019 to just 0.2% growth in 2020.

In response to the uncertain outlook, naturally, most households reduced their spending as a precaution. However, others simply saved more accidently. Restrictions on freedoms not only stopped them spending on goods, but even more so on services. As a result, the eurozone’s household savings rate rose from 13.1% of nominal disposable income in 2019, to 20% in 2020.

Looking ahead, we expect growth in disposable income growth to recover progressively, but also for the savings rate to fall gradually to more normal levels. However, the path of the savings rate is very important for overall consumption.

To illustrate this, we present a simple but very realistic scenario to explore the probable outlook for consumption growth.

We start with nominal disposable income, which we assume will gradually recover to 5% growth (about 3.5% in real terms) by the end of 2022, and remain there for 2023 (chart 4).

For the savings rate, we could have assumed a gradual fall back to the average 13%, but decided that households are more likely to spend some of the excess savings they have built up. So instead, we have the savings rate falling to 10% by the end of 2022, then rising back to 13% by the end of 2023 (chart 5).


The combination of the recovery in disposable income, and the path laid out for the savings rate yields the consumption growth path as shown by the green line in chart 5.

Nominal household consumption growth recovers from -7.6% at the end of 2020 to peak at +11% at the end of 2022, before falling back in 2023. More on 2023 later.

These calculations are done in nominal terms, and we use our forecast for the Harmonised Index of Consumer Prices (HICP) to deflate consumption back into real terms. In this illustrative scenario, consumption rises from -8% in 2020 to 5.9% in 2021 and 7.6% in 2022. This would be an incredibly strong. The next highest year of consumption growth would be back in 1999, when it grew by 3.3%.

The large rise in 2022 also includes some spending of the built-up excess savings that have been accumulated through 2020. This is often overlooked by forecasters, but will be an important factor for determining demand going forward.

In 2020, eurozone households saved €1.45 trillion – a 53% increase compared to the previous year. To help put in context the scale of pent-up demand, we compared nominal actual (2020) and projected savings with the normal levels of savings in chart 6.

In addition in chart 7, we show excess savings as a percentage of normal savings (green line),  along with the accumulation over time (blue line), and finally, the purple bars show the what the accumulated savings are worth when compared to 2019 consumption.


We have three observations from this analysis.

The first is that even in 2021, where the savings rate falls, households accumulate more savings than normal levels. We assume that the savings rate falls to 10% in 2022, and only then do savings dip below normal for the year, as some of the excess savings are spent.

The second observation is that by the end of the simulation in 2023, households will still have excess savings worth just under 4% of 2019 consumption, or about 2% of GDP. This presents further upside risks to future forecasts.

Finally, the rise in the savings rate from 10% back to the normal level of 13% in 2023 would cause consumption to fall back sharply. The simulation has nominal consumption growth falling by 0.4%, and falling by 2.1% in real terms. Given just over half of GDP growth is coming from consumption, this dramatically raises the risk of recession, and would certainly call into question any plans to tighten fiscal or monetary policy at that point in time.

Some health warnings should be considered before making too many conclusions. Scarred by the pandemic, households may decide to maintain a higher than normal savings rate. This would mean less growth in near-term, but still some rebound should be expected.

Households may not choose to spend their excess savings, and so the overshoot and rebound in the savings rate may not occur. This would lead to a smoother glide path to the new equilibrium, and reduce the risk of a recession at a later point.

However, a recent survey conducted by YouGov found that between a quarter and a third of respondents in Germany, France, Italy and Spain said they plan to spend at least half of the savings accumulated during the coronavirus pandemic (chart 8).

Only between 16% and 23% said they would keep all of the excess savings, making this low risk.


Inflation risks?

As mentioned earlier, evidence from business surveys points to supply shortages and production bottlenecks forcing firms to raise their prices of late.

If these conditions are met with a sudden burst of strong demand thanks to falling savings rates, companies may well respond with further price increases. This would especially be the case if they believe that the level of demand is temporary and/or unsustainable.

Higher prices will deter some spending, but also, it means that more of the growth in spending will be lost to inflation, and so will not translate to stronger economic growth in real terms.

Moreover, the extensive use of administered prices in the eurozone (where some prices are automatically raised by recent inflation) mean that the higher period of inflation could persist for longer than in other regions. This increases the risk of workers demanding higher pay to compensate, which in turn raises costs for companies, and potentially triggers what is often referred to as a second-round effect.

The European Central Bank (ECB) will probably not respond to when faced with much higher inflation in the near-term.

As part of its long-term strategy review, the ECB has just changed its inflation target, moving to a symmetric target of 2%, without specifying any bands (like the Bank of England’s 1 percentage point bands).  

Specifically, in the latest ECB press conference, president Christine Lagarde stated that:

“…the Governing Council expects the key ECB interest rates to remain at their present or lower levels until we see inflation reaching two per cent well ahead of the end of our projection horizon and durably for the rest of the projection horizon, and we judge that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at two per cent over the medium term. This may also imply a transitory period in which inflation is moderately above target.”

This essentially provides the ECB with far more flexibility than its previous target. Any sign that inflation could be below 2% over the next three years would implicitly support the ECB’s simulative policies.


Compared to our baseline forecast, the simulated projection for consumption, and therefore GDP growth, is significantly stronger and therefore presents an upside risk for our 2021 and 2022 forecasts.

We do not yet have a formal forecast for 2023, but the rise in the savings rate from the simulation suggests a period of weakness, and elevated risk of recession. The latter would make tightening fiscal and monetary policy politically more difficult.

Given the new ECB mandate, the governing council would have plenty of excuses not to raise interest rates if household spending was to slow to such an extent.

Also, it’s worth mentioning that when it comes to inflation, investors should not assume that Europe is in a similar situation to the US.

While investors worry about a genuine inflation problem over the medium term in the US, and therefore the reaction of the Federal Reserve, Europe is starting from a lower level. This may mean that by the end of next year, the ECB could return to worry more about deflation rather than inflation.