Euro Macro: Deeper double dip but stronger upswing – The governments of all of the larger eurozone economies have announced new (partial) lockdown measures in recent days and weeks.

Although we have long incorporated a double dip recession in our baseline scenario for the eurozone economy, the new lockdowns mean that we now incorporate a deeper recession than previously expected.

The contraction we now expect in Q4 of this year and Q1 of next year is much less severe than in the first half of this year (a little under a third of the GDP drop that we saw then) but is still a deep recession from a historical perspective. So that was the bad news.

The good news is that we now expect a stronger economic recovery from 2021Q2 onwards as vaccine developments should allow a somewhat speedier lifting of restrictions. Still, while our conviction on a near term double dip remains high, our assumptions on vaccine developments are of course surrounded by uncertainty.

Not all lockdowns are equal – A key difference between the current lockdown measures compared to the previous ones in March-April is that people that are not able to work from home (e.g. in construction and industry) will be allowed to continue to go to work.

Also, non-essential shops are allowed to remain open in most countries and regions, although sometimes with more limited opening hours. Moreover, day-care centres and schools are allowed to remain open, which also enables more people to continue working than during the first wave of the pandemic. Finally, (air) traffic between eurozone countries has been restricted less severely than during the first wave of the pandemic.

All in all, the current restrictions are more targeted at further limiting social interaction between people by closing (or seriously restricting the opening hours) of restaurants, cafes and museums and by prohibiting sports, leisure and cultural events.

Not as deep as H1 When assessing the blow to the economy from these new lockdown measures it is important to note that the sectors that will be hit were already functioning well below full capacity before the new lockdown measures became effective, as activity had remained limited by social distancing regulations.

Therefore, the contraction in activity will be less severe than during the first lockdowns. Another difference is that the global manufacturing sector is still in a recovery phase and will not be hindered by the lockdown measures this time, while there will neither be serious supply chain disruptions stemming from China.

Manufacturing will also slow due to an expected cut back in capital spending plans, but the sector should be more resilient than it was earlier this year. All things considered, we expect GDP to contract by almost 4% qoq in Q4.

Stronger recovery next year as restrictions lift – Looking further ahead, we expect that some of the most stringent measures that have recently been taken will be softened somewhat from the end of Q1, albeit very gradually to prevent a new (third) wave of the virus.

As there will be a negative base effect from the drop in GDP in November, we expect GDP to contract in 2021Q1 despite a modest rise in monthly activity during that quarter.

As from the middle of next year onwards, GDP growth is expected to jump higher on a more sustainable basis, as lockdown measures are expected to be unwound further, a vaccine becomes available and the impact of global monetary and fiscal stimulus kicks in (we set out our assumptions about the timing of a vaccine and the lifting of restrictions below). On an annual basis, GDP should drop by around 7.5% in 2020, grow by almost 3% in 2021 and by almost 5% in 2022.

Huge spare capacity remains – At the end of 2021, the level of GDP should be around 2 percent below the pre-pandemic level and around 5% below the trend-level.

By the end of 2022, the level of GDP should have returned to approximately pre-pandemic levels, but there will continue to be a sizeable gap between actual GDP and the trend-level. As such, we continue to take the view that core inflation will get stuck close to zero over the medium term (even though a recovery in core and headline inflation is likely over the next year or so).