Chart of the week: European recovery on track – but still at risk

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● More like a V? On both sides of the Atlantic, economic data have surprised to the upside in the last few weeks. Relieved about the easing of lockdowns and helped by generous government support, consumers opened their wallets in May more than expected. The 17.7% surge in US retail sales in May made headlines. For once, however, German consumers delivered an even bigger surprise. Whereas US retail sales in May still fell 6.7% short of their February level, Germans spent 3.6% more in actual (and virtual) shops in May than at the pre-pandemic peak in February. Is the advanced world in for a V-type rebound rather than the tick-shaped recovery which we project?

● The usual shape of the cycle: The run-up to a cyclical recovery often follows a typical pattern. In many cases, a monetary impulse creates the room for a faster expansion of demand, often with some fiscal support. Financial markets reflect the stimulus and the resulting hope for a rebound. Easier financial conditions in equity and credit markets help to transmit the impulse to the real economy. Shortly after a rebound in business expectations, actual output starts to grow again.

● Cyclical dynamics in times of the virus: Since February, economic activity has been shaped more by supply than by demand. After harsh lockdowns to contain the pandemic caused a record plunge in output in March and April, the easing of restrictions has allowed for a rebound since May. Nonetheless, the usual demand dynamics seem to be unfolding as well in fast motion. After a huge sell-off in March, which we rated as an irrational panic, equity markets have recovered most of their losses. Right after a surge in output expectations, indicators of output have now also turned up.

● Our call – not a V: After an initial rapid but not quite V-shaped snap-back effect as lockdowns are eased, we expect the pace of output growth to moderate. Scarred by the crisis, consumers and businesses will not return to normal spending habits in a rush. In our view, economic activity in the Eurozone will take two years to reach its pre-pandemic level.

● Growth takes time: The V-shaped pattern of our chart does not contradict our call for a more muted recovery. Equity markets try to play the future. Against the backdrop of ultra-low interest rates, ample liquidity and a clear central bank commitment to nip any financial stress in the bud, expectations that activity will return to normal in two years’ time suffice to underpin equity valuations. Also, the record surge in production expectations from negative to neutral mostly suggests that companies no longer look for a further decline in output rather than a record pace of output growth.

● Watching the US risk: On the heels of a record surge in confirmed infections, the number of people hospitalised with COVID-19 in the US has risen from 8.2 per 100,000 inhabitants in mid-June to 11.2 on 2 July. Although well shy of the mid-April peak of 17.9, the trend looks alarming. We base our calls on the assumption that targeted, regional and only modestly disruptive measures will suffice to manage the situation. On a six- to 12-month view, equities would then have further upside potential. But the risk is obvious. Near-term, current valuations leave little room for downside surprises.

Holger Schmieding

Chief Economist

+44 20 3207 7889

[email protected]

Kallum Pickering

Senior Economist

+44 20 3465 2672

[email protected]

Florian Hense

European Economist

+44 20 3207 7859

[email protected]

Disclosures

This material is intended as commentary on political, economic or market conditions for institutional investors or market professionals only and does not constitute a financial analysis or a research report as defined by applicable regulation. See the "Disclaimers" section of this report.

The commentary included herein was produced by Joh. Berenberg, Gossler & Co. KG (Berenberg). For sales inquiries, please contact:

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