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The euro area is currently experiencing its fourth COVID wave with infection rates that clearly exceed the previous waves, particularly, in countries where the vaccinated share of the population is rather low. In September, excess mortality had already increased by 12% compared with the years 2016-2019. To date, Southern European countries like Italy, Spain and Portugal hit hard last year have done better as very strict lockdowns and high fatalities in previous waves have led to higher vaccination rates and public acceptance of strict measures. Realizing that the current wave is much stronger than the one that started with the indoor season last year, several governments are now starting to restrict mobility again. Austria was the first country to introduce a lockdown for the non-vaccinated part of the population. Others are sure to follow, and mobility indicators are all but certain to fall as well. We expect this curtailed mobility to weigh on service sector activities again this autumn and winter. And for some households, staying at home wouldn’t be all that bad if heating costs weren’t so high this year.
Driving the cost rise, is the strong increase in energy prices – the second adverse development that the euro area is facing now. Oil prices have roughly doubled and the price of natural gas in euros have risen more than sevenfold in the last 12 months as gas inventories are far below their normal seasonal level. Gas prices got another boost from decision of German regulators to hold back the certification of the new Nord Stream 2 gas pipeline earlier this month. Overall, the energy component in the euro area inflation basket has increased by 23.7% year-on-year. With a weight of 9.9%, this means that energy prices are responsible for 2.3 percentage points or more than half of the overall inflation rate of 4.1%. As the weights in the inflation basket are based on household expenditure patterns, it can be said that changes decrease real household income by the same amount. Given that consumers rapidly notice when prices go up at the pump, this is likely to weigh on consumer confidence beyond the effect on their purchasing power, in particular at the bottom end of the income distribution.
The third adverse development for the European economy is the severe supply bottlenecks and lengthening supplier delivery times. These trends might be most pronounced in the automobile sector that is producing at 72% of its full capacity partly due to the semiconductor shortage. This is far below the overall capacity utilization of 84.7% in the manufacturing sector. Now nearly all industries and service sectors report shortages of physical capital and labour. In the medium term, this makes us confident that investment spending will speed up, prolonging the business cycle. Clearly, a recession would be highly unusual in a situation of excess demand. So far, production has been holding up quite well. Growing by 2.2% quarter-on-quarter in Q3, GDP has reached 99.3% of its pre-COVID level. Employment increased by 0.9% quarter-on-quarter as many sectors opened up after the COVID-related lockdowns in Q2. However, we have noticed that this dynamic has recently been fading again. Industrial production and exports declined in August and September. September retail trade was weak as well. Passenger car registrations increased in September after two negative months but they declined by over 30% year-on-year in October. While sentiment indicators remain at elevated levels, however, we have noted that expectations are lower than current output components, pointing to a weaker dynamic ahead.
Taking all of these together, we expect that the new COVID-wave, higher energy prices and existing supply bottlenecks will slow euro area growth to 0.4% quarter-on-quarter, which is clearly below the current consensus estimate of 0.8% quarter-on-quarter or the ECB-forecast of 1.1%. Be prepared for further bad news and a return to above-trend growth only if the current headwinds abate next year.
