Euro area: The worst is over, but we are not yet in the clear

T he euro area economy is re-awaken ing a s containment measures are lifted . While we can be now certain that the worst is behind us, there remains a high degree of uncertainty how things will play out during the second half of th is year. The biggest risk at this stage is clearly a significant second wave of new infections that would force government s to reinstate nationwide lockdowns. Barring a second wave, w e think that the conditions for a strong rebound in activity during Q3 remain in place. The lifting of containment measures in combination with strong support from fiscal and monetary policy will kickstart positive multipliers that will lift the economy from its current depressed levels. This process has partially already started as reflected in latest data points. Two crucial factors will determine how vigorous the rebound in activity will be during the second half of this year. The first concerns private households ’ savings rate, which is at record highs. The second relates to corporate leverage and to what extent higher indebtedness will weigh o n corporate investment spending. While both factors will no t prevent the economy to recover, they will nevertheless constitute a headwind that will slow the recovery. Moreover, some containment measures are likely to remain in place in any case and this may also weigh on activity. Consequently , we expect the economy not to fully recovery until 2022 (see the table and charts on the left-hand side) . From this also follows that the underlying inflationary pressure will remain very muted and we expect core inflation to stay around 1% over the forecast horizon. This in turn will allow the ECB to make full use of its balance sheet to keep financial conditions accommodative and to provide a financial backstop for governments.